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PACIFIC HORIZON FUNDS, INC.
(THE "COMPANY")
AGGRESSIVE GROWTH, ASSET ALLOCATION, BLUE CHIP,
CALIFORNIA TAX-EXEMPT BOND, CAPITAL INCOME,
CORPORATE BOND, FLEXIBLE BOND, NATIONAL MUNICIPAL BOND
AND U.S. GOVERNMENT SECURITIES FUNDS
(COLLECTIVELY, THE "FUNDS" AND INDIVIDUALLY, A "FUND")
SUPPLEMENT DATED MARCH 8, 1996
TO PROSPECTUSES DATED JULY 1, 1995
1. The sales load structure with respect to each Fund is amended as
follows.
There is no front-end sales load on combined purchases of shares of the
Company of $1,000,000 or more ("Large Purchase Exemption"). Shares purchased
under the Large Purchase Exemption are subject to a contingent deferred sales
charge of 1.00% and 0.50%, respectively, on redemptions within one and two
years after purchase. The contingent deferred sales charge is paid to the
Distributor. Shares cannot be purchased under the Large Purchase Exemption if
there is another no-load exemption available. Accordingly, shares purchased
under another no-load exemption are not subject to a contingent deferred sales
charge.
Neither a contingent deferred sales charge nor a front-end sales load
will be imposed if a shareholder who has entered a Fund under the Large
Purchase Exemption exchanges shares between funds of the Company or Time
Horizon Funds. However, shares acquired in the exchange will remain subject to
the contingent deferred sales charge discussed above. The contingent deferred
sales charge is calculated as a percentage of the lesser of the current market
value or the cost of the shares being redeemed. This means that this charge
will not be imposed upon increases in net asset value above the initial
purchase price or upon reinvested dividends. In determining whether a
contingent deferred sales charge is applicable to a redemption of such shares,
the calculation will be made in a manner that results in the lowest possible
rate. It will be assumed that the redemption is made first of amounts
representing shares acquired pursuant to the reinvestment of dividends and
distributions; then of amounts representing the increase in net asset value of
your holdings of shares above the total amount of payments for the purchase of
shares during the preceding 2 years; then of amounts representing the cost of
shares held beyond the applicable contingent deferred sales charge period; and
finally, of amounts representing the cost of the shares held for the longest
period of time.
Despite the fact that no front-end sales load will be paid on shares
purchased under the Large Purchase Exemption, the Distributor will compensate
brokers whose customers purchase such shares at the following rates: 1.00% of
the amount under $3 million, 0.50% of the next $47 million and 0.25%
thereafter.
The preceding paragraphs are inserted immediately below the table
entitled "SHAREHOLDER TRANSACTION EXPENSES" under the heading "EXPENSE
SUMMARY." The
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contingent deferred sales charge has not been included in calculating the
expenses in the "EXPENSE SUMMARY" sections.
The chart under the heading "SHAREHOLDER GUIDE - HOW TO BUY SHARES -
HOW ARE SHARES PRICED? - SALES LOAD" is amended and restated in its entirety
for each Fund as follows:
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AS A % OF AS A % OF DEALER'S
OFFERING NET ASSET REALLOWANCE
PRICE VALUE AS A % OF
AMOUNT OF TRANSACTION PER SHARE PER SHARE OFFERING PRICE*
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Less than $100,000 4.50 4.71 4.00
$100,000 but less than $250,000 3.75 3.90 3.35
$250,000 but less than $500,000 2.50 2.56 2.20
$500,000 but less than $750,000 2.00 2.04 1.75
$750,000 but less than $1,000,000 1.00 1.01 0.90
$1,000,000 or more 0.00** 0.00** 0.00**
* Dealer's reallowance may be changed periodically.
** See 1 above for a description of the contingent deferred sales charge.
From time to time, the Fund's distributor will make or allow additional payments or
promotional incentives in the form of cash or other compensation such as trips to sales
seminars, tickets to sporting and other entertainment events and gifts of merchandise
to firms that sell shares of the Fund.
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2a. With respect to the Asset Allocation Fund, the tables entitled "ANNUAL
FUND OPERATING EXPENSES" and "EXAMPLE" under the heading "EXPENSE SUMMARY" in
the Prospectus are amended and restated in their entirety as follows:
ANNUAL FUND OPERATING EXPENSES
(as a percentage of average net assets)
Management Fees (after fee waivers) 0.09%
All Other Expenses (after expense reimbursements) 1.16%
----
Shareholder Service Payments 0.25%
Other Expenses (after expense reimbursements) 0.91%
----
Total Operating Expenses
(after fee waivers and expense reimbursements) 1.25%
====
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EXAMPLE: Assume the annual return is 5% and operating expenses are
the same as those stated above. For every $1,000 you invest, here's how
much you would have paid in total expenses if you closed your account
after the number of years indicated:
After 1 Year After 3 Years After 5 Years After 10 Years
$57 $83 $111 $189
Note: The preceding operating expenses and example should not be
considered a representation of future investment returns and operating
expenses. Actual investment returns and operating expenses may be more
or less than those shown.
2b. With respect to the Asset Allocation Fund, the fifth paragraph under
the heading "EXPENSE SUMMARY" in the Prospectus is amended and restated in its
entirety as follows:
As indicated in the table above, Management intends to waive
fees and reimburse certain Other Expenses on behalf of the Fund so that
Total Operating Expenses do not exceed 1.25%. Absent these fee waivers
and reimbursements, the Total Operating Expenses would be 3.82% of the
Fund's average daily net assets.
3a. With respect to the Blue Chip Fund, the tables entitled "ANNUAL FUND
OPERATING EXPENSES" and "EXAMPLE" under the heading "EXPENSE SUMMARY" in the
Prospectus are amended and restated in their entirety as follows:
ANNUAL FUND OPERATING EXPENSES
(as a percentage of average net assets)
Management Fees (after fee waivers) 0.15%
All Other Expenses (after expense reimbursements) 1.15%
----
Shareholder Service Payments 0.25%
Other Expenses (after expense reimbursements) 0.90%
----
Total Operating Expenses
(after fee waivers and expense reimbursements) 1.30%
====
EXAMPLE: Assume the annual return is 5% and operating expenses are
the same as those stated above. For every $1,000 you invest, here's how
much you would have paid in total expenses if you closed your account
after the number of years indicated:
After 1 Year After 3 Years After 5 Years After 10 Years
$58 $84 $113 $195
Note: The preceding operating expenses and example should not be
considered a representation of future investment returns and operating
expenses. Actual investment returns and operating expenses may be more
or less than those shown.
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3b. With respect to the Blue Chip Fund, the fifth paragraph under the
heading "EXPENSE SUMMARY" in the Prospectus is amended and restated in its
entirety as follows:
As indicated in the table above, Management intends to waive
fees and reimburse certain Other Expenses on behalf of the Fund so that
Total Operating Expenses do not exceed 1.30%. Absent these fee waivers
and reimbursements, the Total Operating Expenses would be 4.55% of the
Fund's average daily net assets.
4. BISYS Fund Services, Inc., 3435 Stelzer Road, Columbus, Ohio
43219-3035, phone number 800-346-2087, will serve as transfer and dividend
disbursing agent for the Funds.
5. An investor desiring to make an initial purchase of shares of a Fund by
mail should complete an Account Application and mail the Application and a
check payable to the appropriate Fund to the address on the Account
Application. All subsequent purchases of shares of a Fund made by mail should
be delivered to Pacific Horizon Funds, Inc., File No. 54634, Los Angeles,
California 90074-4634.
6. Initial and subsequent purchases and redemptions of shares of a Fund
made in person should be delivered to BISYS Fund Services, Inc., 3435 Stelzer
Road, Columbus, Ohio 43219-3035.
7. An investor desiring to make a subsequent purchase of shares of a Fund
into an already existing account by wire should contact the Fund's transfer
agent at 800-346-2087 for complete wiring instructions and request his or her
bank to transmit immediately available funds by wire for purchase of shares of
a Fund in the investor's name. The wire should include the investor's name and
fund account number. An investor should contact his or her bank for information
on remitting funds in this manner, including any charges imposed by the bank
for wiring funds. Initial purchases of shares into a new account may not be
made by wire.
8. An investor desiring to redeem shares of a Fund by mail should deliver
a written request to the appropriate Fund, c/o Pacific Horizon Funds, Inc.,
P.O. Box 80221, Los Angeles, California 90080-9909.
9. To elect to receive dividend payments in cash, or to revoke such
election, an investor must do so in writing to the Transfer Agent at P.O. Box
80221, Los Angeles, California 90080-9909.
10. The last sentence of the section below the heading "SHAREHOLDER GUIDE -
HOW TO BUY SHARES - HOW ARE SHARES PRICED?" in the Prospectus is restated in
its entirety to read as follows: "For price and yield information call (800)
346-2087."
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11. The third sentence of the second paragraph below the heading
"SHAREHOLDER GUIDE - HOW TO BUY SHARES - WHAT PRICE WILL I RECEIVE WHEN I BUY
SHARES?" in the Prospectus is restated in its entirety to read as follows:
"Purchase orders received by a Service Organization in proper form by
4:00 p.m. Eastern time on a business day will be effected at the public
offering price calculated at 4:00 p.m. Eastern time on that day, if the Service
Organization transmits your order to the Transfer Agent by the end of the
Transfer Agent's business day."
12. Shares of Time Horizon Funds will not be included when determining
reduced sales loads under the rights of accumulation or letter of intent
programs.
13. The following sentence, constituting the last sentence of the first
paragraph below the heading "SHAREHOLDER GUIDE - HOW TO SELL SHARES - HOW
QUICKLY CAN I RECEIVE MY REDEMPTION PROCEEDS?," is eliminated:
"If you purchase shares by wire, you must file an Account Application
before redemption requests can be honored."
14. Certificates for shares will not be issued.
15. The minimum initial investment in shares of a Fund is $200 for
BankAmericard holders with an appropriate award certificate from
BankAmeriChoice Program.
16. With respect to each Fund except the California Tax-Exempt Bond Fund
and the National Municipal Bond Fund, the third and fourth exemptions contained
in the list of types of transactions exempt from the front-end sales load
appearing below the heading "SHAREHOLDER GUIDE - HOW TO BUY SHARES - HOW ARE
SHARES PRICED? - WHEN NO SALES LOAD IS APPLIED" in the prospectus are amended
and restated in their entirety to read as follows:
-- employer-sponsored employee pension or retirement plans making
direct investments in the Fund other than 403(b) plans; provided that 403(b)
plans invested in the Funds as of December 7, 1995 may continue to invest on a
no-load basis;
-- any purchase of shares by an investment adviser regulated by
federal or state governmental authority when the investment adviser is
purchasing shares for its own account or for an account for which it is
authorized to make investment decisions (i.e., a discretionary account) other
than purchases for 403(b) plans; provided that investment advisers who have
invested 403(b) plans in the Funds on behalf of existing and new clients as of
December 7, 1995 may continue to invest on a no-load basis;
17. The sixth exemption (fourth exemption with respect to the California
Tax-Exempt Bond and National Municipal Bond Funds) contained in the list of the
types of transactions
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exempt from the front-end sales load appearing below the heading "SHAREHOLDER
GUIDE - HOW TO BUY SHARES - HOW ARE SHARES PRICED? - WHEN NO SALES LOAD IS
APPLIED" in the prospectus is amended and restated in its entirety to read as
follows with respect to each Fund:
-- any purchase of shares by clients of The Private Bank of Bank of
America Illinois or by Private Banking clients of Seattle-First
National Bank or by or on behalf of agency accounts administered
by any bank or trust company affiliate of Bank of America;
18. The following exemption is added with respect to each Fund to the list
of types of transactions exempt from the front-end sales load appearing below
the heading "SHAREHOLDER GUIDE - HOW TO BUY SHARES - HOW ARE SHARES PRICED? -
WHEN NO SALES LOAD IS APPLIED":
-- any purchase of shares of the Fund, provided that (i) you are
investing proceeds from a redemption of shares from another
open-end investment company on which you paid a front-end sales
load, (ii) such redemption occurred within 30 days prior to the
purchase order, and (iii) such other open-end investment company
is not distributed and advised by Concord Financial Group, Inc.
and Bank of America, respectively, or their affiliates.
19. The second exemption contained in the list of individuals exempt from
the front-end sales load appearing below the heading "SHAREHOLDER GUIDE - HOW
TO BUY SHARES - HOW ARE SHARES PRICED? - WHEN NO SALES LOAD IS APPLIED" in the
prospectus is amended and restated in its entirety to read as follows with
respect to each Fund:
-- U.S. based employees and retirees (including employees who are
U.S. citizens but work abroad and retirees who are U.S. citizens
but worked abroad) of Bank of America or any of its affiliates,
and their parents, spouses, minor children and grandchildren, as
well as members of the Board of Directors of Bank of America or
any of its affiliates.
20. The following exemption is added with respect to each Fund to the list
of individuals exempt from the front-end sales load appearing below the heading
"SHAREHOLDER GUIDE - HOW TO BUY SHARES - HOW ARE SHARES PRICED? - WHEN NO SALES
LOAD IS APPLIED" in the prospectus:
-- holders of the BankAmericard with an appropriate award
certificate from the BankAmeriChoice Program.
21. With respect to the Corporate Bond and Flexible Bond Funds, the fourth
paragraph under the heading "SERVICE PROVIDERS - INVESTMENT ADVISER" in the
prospectus is replaced with the following:
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Effective March 8, 1996, portfolio management services for the
Portfolio are conducted by the Fixed Income Division of the
Investment Management Services Group of Bank of America.
22. With respect to the U.S. Government Securities Fund, the fourth
paragraph under the heading "SERVICE PROVIDERS - INVESTMENT ADVISER" in the
prospectus is replaced with the following:
Effective March 8, 1996, portfolio management services for the
Fund are conducted by the Fixed Income Division of the
Investment Management Services Group of Bank of America.
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<PAGE> 8
PACIFIC HORIZON FUNDS, INC.
(THE "COMPANY")
STATEMENT OF ADDITIONAL INFORMATION
STATEMENT OF ADDITIONAL INFORMATION
FOR
AGGRESSIVE GROWTH FUND
CALIFORNIA TAX-EXEMPT BOND FUND
U.S. GOVERNMENT SECURITIES FUND
CAPITAL INCOME FUND
JULY 1, 1995
(AS REVISED MARCH 8, 1996)
TABLE OF CONTENTS
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Page
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<S> <C>
The Company............................................................... 2
Investment Objectives and Policies........................................ 2
Additional Purchase and Redemption Information............................ 51
Additional Information Concerning Taxes................................... 60
Management................................................................ 66
General Information....................................................... 87
Appendix A................................................................ A-1
Appendix B................................................................ B-1
</TABLE>
This Statement of Additional Information applies to the Pacific Horizon
Aggressive Growth Fund ("Aggressive Growth Fund"), Pacific Horizon California
Tax-Exempt Bond Fund ("California Tax-Exempt Bond Fund"), Pacific Horizon U.S.
Government Securities Fund ("U.S. Government Securities Fund") and Pacific
Horizon Capital Income Fund ("Capital Income Fund"), of the Company. This
Statement of Additional Information is meant to be read in conjunction with the
Prospectuses dated July 1, 1995, as they may from time to time be revised
(individually, a "Prospectus" and collectively, the "Prospectuses"), which
describe the particular Fund of the Company in which the investor is interested.
This Statement of Additional Information is incorporated by reference in its
entirety into each such Prospectus. Because this Statement of Additional
Information is not itself a prospectus, no investment in shares of any Fund
should be made solely upon the information contained herein. Copies of the
Prospectuses relating to the Company's Funds to which this Statement of
Additional Information relates may be obtained by calling Concord Financial
Group, Inc. at 800-332-3863. Capitalized terms used but not defined herein have
the same meaning as in the Prospectuses.
<PAGE> 9
THE COMPANY
The Company was organized on October 27, 1982 as a Maryland
corporation. The Aggressive Growth Fund commenced operations on March 30, 1984.
The California Tax-Exempt Bond Fund originally commenced operations on March 30,
1984 as a separate portfolio of Pacific Horizon Tax-Exempt Funds, Inc., which
subsequently changed its name to Pacific Horizon California Tax-Exempt Bond
Portfolio, Inc. (the "Predecessor California Tax-Exempt Bond Fund"). The Capital
Income Fund originally commenced operations on September 25, 1987 as The Total
Return Fund (the "Predecessor Capital Income Fund"), a separate portfolio of a
Massachusetts business trust named The Horizon Capital Funds. The U.S.
Government Securities Fund commenced operations on January 7, 1988, also as a
separate portfolio of The Horizon Capital Funds, under the name GNMA Extra Fund
(the "Predecessor GNMA Fund" or the "Predecessor U.S. Government Securities
Fund"). On January 1, 1989 the Predecessor Capital Income Fund and the
Predecessor GNMA Fund changed their names to the Pacific Horizon Convertible
Securities Fund and the Pacific Horizon GNMA Extra Fund. In January 1990 these
three Predecessor Funds were reorganized as portfolios of the Company. On June
28, 1991, the GNMA Extra Fund changed its name to the U.S. Government Securities
Fund and on September 16, 1991 the Convertible Securities Fund changed its name
to the Capital Income Fund.
The Company also offers other investment portfolios which are described
in separate Prospectuses and Statements of Additional Information. For
information concerning these other portfolios contact the Distributor at the
telephone number stated on the cover page of this Statement of Additional
Information.
INVESTMENT OBJECTIVES AND POLICIES
The Prospectus for each Fund describes the investment objective of the
Fund to which it applies. The following information supplements and should be
read in conjunction with the descriptions of the investment objective and
policies in the Prospectus for each Fund.
PORTFOLIO TRANSACTIONS
The portfolio turnover rate described in each Prospectus is calculated
by dividing the lesser of purchases or sales of portfolio securities for the
year by the monthly average value of the portfolio securities. The calculation
excludes all securities whose maturities at the time of acquisition were one
year or less. Portfolio turnover may vary greatly from year to year as well as
within a particular year, and may also be affected by cash requirements for
redemptions of shares and by requirements which enable the Company to receive
certain favorable tax treatment. Portfolio turnover will not be a
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<PAGE> 10
limiting factor in making portfolio decisions. The portfolio turnover rate for
the Aggressive Growth Fund, U.S. Government Securities Fund and Capital Income
Fund may be particularly high. For the fiscal years ended February 28, 1995 and
1994, the portfolio turnover rates for the Aggressive Growth Fund were 92% and
43%, respectively; the portfolio turnover rates for the U.S. Government
Securities Fund were 189% and 255%, respectively; the portfolio turnover rates
for the California Tax-Exempt Bond Fund were 20% and 15%, respectively; and the
portfolio turnover rates for the Capital Income Fund were 94% and 103%,
respectively.
Subject to the general control of the Company's Board of Directors,
Bank of America National Trust and Savings Association ("Bank of America" or the
"investment adviser") is responsible for, makes decisions with respect to and
places orders for all purchases and sales of portfolio securities for each Fund.
Transactions on stock exchanges involve the payment of negotiated
brokerage commissions. There is generally no stated commission in the case of
securities traded in the over-the-counter market, but the price includes an
undisclosed commission or mark-up. The cost of 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. Purchases and sales of portfolio securities for the U.S.
Government Securities Fund and California Tax-Exempt Bond Fund are normally
principal transactions without brokerage commissions. During the fiscal years
ended February 28, 1995, 1994 and 1993, the Aggressive Growth Fund paid
$631,202, $267,276 and $185,309, respectively, in brokerage commissions; and the
Capital Income Fund paid $207,310, $110,588 and $15,477, respectively, in
brokerage commissions. During these same three fiscal years, the California
Tax-Exempt Bond Fund and the U.S. Government Securities Fund paid no brokerage
commissions.
In executing portfolio transactions and selecting brokers or dealers,
it is the Company's policy to seek the best overall terms available. The
Investment Advisory Agreements between the Company and Bank of America provide
that, in assessing the best overall terms available for any transaction, Bank of
America shall consider factors it deems 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, for the specific transaction and on a continuing basis. In
addition, the Investment Advisory Agreements authorize Bank of America, subject
to the approval of the Board of the Company, to cause the Company to pay a
broker-dealer which furnishes brokerage and research services a higher
commission than that which might be charged by another broker-dealer for
effecting the
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<PAGE> 11
same transaction, provided that such commission is deemed reasonable in terms of
either that particular transaction or the overall responsibilities of Bank of
America to the particular Fund or Company. Brokerage and research services may
include: (1) advice as to the value of securities, the advisability of investing
in, purchasing or selling securities and the availability of securities or
purchasers or sellers of securities; and (2) analyses and reports concerning
industries, securities, economic factors and trends, portfolio strategy and the
performance of accounts.
It is possible that certain of the brokerage and research services
received will primarily benefit one or more other investment companies or other
accounts for which investment discretion is exercised. Conversely, the Company
or any given Fund may be the primary beneficiary of the brokerage or research
services received as a result of portfolio transactions effected for such other
accounts or investment companies.
Brokerage and research services so received are in addition to and not
in lieu of services required to be performed by Bank of America and do not
reduce the advisory fee payable to Bank of America. Such services may be useful
to Bank of America in serving both the Company and other clients and,
conversely, services obtained by the placement of business of other clients may
be useful to Bank of America in carrying out its obligations to the Company. In
connection with its investment management services with respect to the Funds,
Bank of America will not acquire certificates of deposit or other securities
issued by itself or its affiliates, and will give no preference to certificates
of deposit or other securities issued by Service Organizations. In addition,
portfolio securities in general will be purchased from and sold to affiliates of
the Company, Bank of America, the Distributor and their affiliates acting as
principal, underwriter, syndicate member, market-maker, dealer, broker or in any
other similar capacity, provided such purchase, sale or dealing is permitted
under the Investment Company Act of 1940 (the "1940 Act") and the rules
thereunder.
A Fund may participate, if and when practicable, in bidding for the
purchase of securities of the U.S. Government and its agencies and
instrumentalities directly from an issuer in order to take advantage of the
lower purchase price available to members of a bidding group. A Fund will engage
in this practice only when Bank of America, in its sole discretion subject to
guidelines adopted by the Board of the Company, believes such practice to be in
the interest of the Fund.
To the extent permitted by law, Bank of America may aggregate the
securities to be sold or purchased on behalf of the Funds with those to be sold
or purchased for other investment companies or common trust funds in order to
obtain best execution.
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<PAGE> 12
The Company is required to identify any securities of its regular
brokers or dealers (as defined in Rule 10b-1 under the Investment Company Act of
1940) or their parents held by the Company as of the close of its most recent
fiscal year. As of February 28, 1995: (a) the Treasury Fund held the following
securities, Repurchase Agreement with Goldman, Sachs & Co. in the principal
amount of $95,000,000; Repurchase Agreement with Merrill Lynch Government
Securities, Inc. in the principal amount of $95,000,000; (b) the Prime Fund held
the following securities, Merrill Lynch & Co., Inc., commercial paper in the
principal amount of $100,000,000; Goldman, Sachs Group L.P., Daily Variable Rate
Master Note in the principal amount of $120,000,000; Morgan Stanley Group, Inc.,
Daily Variable Rate Master Note in the principal amount of $120,000,000; Bear
Stearns Co., Inc., Series B, Monthly Variable Rate Note in the principal amount
of $100,000,000; Repurchase Agreement with Goldman, Sachs & Co. in the principal
amount of $120,000,000; (c) the Government Fund held the following securities,
Repurchase Agreement with Goldman, Sachs & Co. in the principal amount of
$40,000,000; Repurchase Agreement with Merrill Lynch Government Securities, Inc.
in the principal amount of $40,000,000; and (d) the Prime Value Fund held the
following securities, Merrill Lynch & Co., Inc., commercial paper in the
principal amount of $7,000,000; Goldman, Sachs Group L.P., Daily Variable Rate
Master Note in the principal amount of $7,000,000; Repurchase Agreement with
Dean Witter Reynolds, Inc. in the principal amount of $8,000,000; Repurchase
Agreement with Goldman, Sachs & Co. in the principal amount of $8,000,000.
Merrill Lynch & Co., Inc., Goldman Sachs & Co., Bear Stearns Co., Inc.,
Morgan Stanley & Co. Incorporated, Shearson Lehman Brothers, Inc. Dean Witter
Reynolds, Inc. and Paine Webber are considered to be regular brokers and dealers
of the Company.
It is possible that unregistered securities purchased by a Fund in
reliance upon Rule 144A under the Securities Act of 1933 (the "1933 Act") could
have the effect of increasing the level of the Fund's illiquidity to the extent
that qualified institutional buyers become, for a period, uninterested in
purchasing these securities.
TYPES OF OBLIGATIONS, INVESTMENT RISKS, AND OTHER INVESTMENT INFORMATION
The following discussion supplements the description of such
investments in the Prospectuses.
Bank Certificates of Deposit, Bankers' Acceptances and Time Deposits.
Except for the U.S. Government Securities Fund, certificates of deposit,
bankers' acceptances and time deposits are eligible investments for each of the
Funds as described in the Funds' Prospectuses. Certificates of deposit are
negotiable
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<PAGE> 13
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. Certificates of deposit and bankers acceptances
will be dollar-denominated obligations of domestic or foreign banks or financial
institutions with total assets at the time of purchase in excess of $2.5 billion
(including assets of both domestic and foreign branches).
Instruments issued by foreign banks or financial institutions may be
subject to investment risks that are different in some respects than the risks
associated with instruments issued by those U.S. domestic issuers. Such risks
include future political and economic developments, the possible imposition of
withholding taxes by the particular country in which the issuer is located on
interest income payable on the securities, the possible seizure or
nationalization of foreign deposits, the possible establishment of exchange
controls or the adoption of other foreign governmental restrictions which might
adversely affect the payment of principal and interest on these securities.
Domestic banks and foreign banks are subject to different governmental
regulations with respect to the amount and types of loans which may be made and
interest rates which may be charged. In addition, the profitability of the
banking industry is dependent largely upon the availability and cost of funds
for the purpose of financing lending operations under prevailing money market
conditions. General economic conditions as well as exposure to credit losses
arising from possible financial difficulties of borrowers play an important part
in the operations of the banking industry.
As a result of federal and state laws and regulations, domestic banks
are, among other things, required to maintain specified levels of reserves,
limited in the amount which they can loan to a single borrower, and subject to
other regulations designed to promote financial soundness. However, such laws
and regulations do not necessarily apply to foreign bank obligations.
In addition to purchasing certificates of deposit and bankers
acceptances, to the extent permitted under their respective investment
objectives and policies stated above and in their Prospectuses, each Fund
(except the U.S. Government Securities Fund) may make interest-bearing time or
other interest-bearing deposits in commercial or savings banks. Time deposits
are non-negotiable deposits maintained at a banking institution for a specified
period of time at a specified interest rate.
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<PAGE> 14
Commercial Paper and Short-Term Notes. The investment policies of the
Funds permit investment in commercial paper and short-term notes. Commercial
paper consists of unsecured promissory notes issued by corporations. Except as
noted below with respect to variable and floating rate instruments, issues of
commercial paper and short-term notes will normally have maturities of less than
9 months and fixed rates of return, although such instruments may have
maturities of up to one year.
Commercial paper and short-term notes will consist of issues rated at
the time of purchase A-2 or higher by Standard & Poor's Ratings Group, Division
of McGraw Hill ("S&P"), Prime-2 or higher by Moody's Investors Service, Inc.
("Moody's"), or similarly rated by another nationally recognized statistical
rating organization ("NRSRO") in the case of purchases by the Aggressive Growth
Fund and California Tax-Exempt Bond Fund, and A-1 or better by S&P, Prime-1 by
Moody's or similarly rated by another NRSRO in the case of purchases by the
Capital Income Fund; or if unrated, will be determined by Bank of America to be
of comparable quality under procedures established by the Board of Directors.
The U.S. Government Securities Fund may only invest in commercial paper rated
A-1 or better by S&P, Prime-1 by Moody's or similarly rated by another NRSRO.
These rating symbols are described in Appendix A.
Other Investment Companies. The U.S. Government Securities Fund may
under certain circumstances invest a portion of its assets in certain money
market funds. The Aggressive Growth Fund may acquire shares of closed-end
investment companies, including companies that invest in foreign issuers, but
only in furtherance of its investment objective. The 1940 Act prohibits each
Fund from investing more than 5% of the value of its total assets in any one
investment company, or more than 10% of the value of its total assets in
investment companies as a group, and also restricts its investment in any
investment company to 3% of the voting securities of such investment company. In
addition, no more than 10% of the outstanding voting stock of any one investment
company may be owned in the aggregate by the Funds and any other investment
company advised by the investment adviser. Investment in other investment
companies will involve payment of the Fund's pro rata share of advisory and
administration fees charged by such fund, in addition to those paid by the Fund.
Repurchase Agreements. Each Fund is permitted to enter into repurchase
agreements with respect to its portfolio securities. Pursuant to such
agreements, a Fund acquires securities from financial institutions such as banks
and broker-dealers as are deemed to be creditworthy subject to the seller's
agreement to repurchase and the agreement of the Fund to resell such securities
at a mutually agreed upon date and price. Although securities subject to a
repurchase agreement may bear
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maturities exceeding ten years, the Funds intend to only enter into repurchase
agreements having maturities not exceeding 60 days. The Funds are not permitted
to enter into repurchase agreements with Bank of America or its affiliates, and
will give no preference to repurchase agreements with Service Organizations. The
repurchase price generally equals the price paid by a Fund plus interest
negotiated on the basis of current short-term rates (which may be more or less
than the rate on the underlying portfolio security). Securities subject to
repurchase agreements will be held by a custodian or sub-custodian of the
Company or in the Federal Reserve/Treasury Book-Entry System. The seller under a
repurchase agreement will be required to deliver instruments the value of which
is 102% of the repurchase price (excluding accrued interest), provided that
notwithstanding such requirement, the adviser shall require that the value of
the collateral, after transaction costs (including loss of interest) reasonably
expected to be incurred on a default, shall be equal to or greater than the
resale price (including interest) provided in the agreement. If the seller
defaulted on its repurchase obligation, a Fund would suffer a loss because of
adverse market action or to the extent that the proceeds from a sale of the
underlying securities were less than the repurchase price under the agreement.
Bankruptcy or insolvency of such a defaulting seller may cause the particular
Fund's rights with respect to such securities to be delayed or limited.
Repurchase agreements are considered to be loans by a Fund under the 1940 Act.
U.S. Government Obligations. Each Fund is permitted to make investments
in U.S. Government obligations. Such obligations include Treasury bills,
certificates of indebtedness, notes and bonds, and issues of such entities as
the Government National Mortgage Association, Export-Import Bank of the United
States, Tennessee Valley Authority, Resolution Funding Corporation, Farmers Home
Administration, Federal Home Loan Banks, Federal Intermediate Credit Banks,
Federal Farm Credit Banks, Federal Land Banks, Federal Housing Administration,
Federal National Mortgage Association, Federal Home Loan Mortgage Corporation,
and the Student Loan Marketing Association. Treasury bills have maturities of
one year or less, Treasury notes have maturities of one to ten years and
Treasury bonds generally have maturities of more than ten years. Some of these
obligations, such as those of the Government National Mortgage Association, are
supported by the full faith and credit of the U.S. Treasury; others, such as
those of the Export-Import Bank of the United States, are supported by the right
of the issuer to borrow from the Treasury; others, such as those of the Federal
National Mortgage Association, are supported by the discretionary authority of
the U.S. Government to purchase the agency's obligations; still others, such as
those of the Student Loan Marketing Association, are supported only by the
credit of the instrumentality. No assurance can be given that the U.S.
Government would provide financial support to U.S. Government
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<PAGE> 16
sponsored instrumentalities if it is not obligated to do so by law.
Variable and Floating Rate Instruments. As described in their
Prospectuses, the Aggressive Growth Fund and the California Tax-Exempt Bond Fund
may acquire variable and floating rate instruments. The U.S. Government
Securities Fund may invest in variable rate GNMA certificates, which are backed
by pools of variable rate mortgages and also in GNMA REMICs. The actual yield on
these instruments varies not only as a result of variations in the lives of the
underlying mortgages, but also as a result of changes in prevailing interest
rates. Such instruments are frequently not rated by credit rating agencies.
However, in determining the creditworthiness of unrated variable and floating
rate instruments and their eligibility for purchase by a Fund, Bank of America
will consider the earning power, cash flow and other liquidity ratios of the
issuers of such instruments (which include financial, merchandising, bank
holding and other companies) and will continuously monitor their financial
condition. An active secondary market may not exist with respect to particular
variable or floating rate instruments purchased by a Fund. The absence of such
an active secondary market could make it difficult to dispose of a variable or
floating rate instrument in the event the issuer of the instrument defaulted on
its payment obligation or during periods that the Fund is not entitled to
exercise its demand rights, and the Fund could, for these or other reasons,
suffer a loss to the extent of the default. Investments in illiquid variable and
floating rate instruments (instruments which are not payable upon seven days'
notice and do not have active trading markets) are subject to a Fund's
fundamental 10% limitation on illiquid securities. Variable and floating rate
instruments may be secured by bank letters of credit.
Zero Coupon Securities. The California Tax-Exempt Bond Fund may also
invest in zero coupon securities which pay no cash income and are sold at
substantial discounts from their value at maturity. When held to maturity, their
entire income, which consists of accretion of discount, comes from the
difference between the purchase price and their value at maturity.
The discount varies, depending on the time remaining until maturity or
cash payment date, prevailing interests rates, liquidity of the security and the
perceived credit quality of the issuer. The discount, in the absence of
financial difficulties of the issuer, decreases as the final maturity or cash
payment date of the security approaches. The market prices of zero coupon and
delayed interest securities are generally more volatile and more likely to
respond to changes in interest rates than the market prices of securities having
similar maturities and credit quality that pay interest periodically. Current
federal income tax law requires that a holder of a zero coupon
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security report as income each year the portion of the original issue discount
on such security (other than tax-exempt original issue discount from a zero
coupon security) that accrues that year, even though the holder receives no cash
payments of interest during the year. Zero coupon securities are subject to
greater market value fluctuations from changing interest rates than debt
obligations of comparable maturities which make current distributions of
interest (cash).
Reverse Repurchase Agreements. As described in the Prospectuses, each
Fund is permitted to borrow funds for temporary purposes by entering into
reverse repurchase agreements with such financial institutions as banks and
broker-dealers in accordance with the investment limitations described therein.
Whenever a Fund enters into a reverse repurchase agreement, it will place in a
segregated account maintained with its custodian liquid assets such as cash,
U.S. Government securities or other liquid high grade debt securities having a
value equal to the repurchase price (including accrued interest) and Bank of
America will subsequently continuously monitor the account for maintenance of
such equivalent value. The Funds intend to enter into reverse repurchase
agreements to avoid otherwise having to sell securities during unfavorable
market conditions in order to meet redemptions. Reverse repurchase agreements
are considered to be borrowings by a Fund under the 1940 Act.
Options Trading. The Aggressive Growth Fund may under certain
circumstances purchase put and call options. Such options may relate to
particular securities or to various stock indices. In addition, the Aggressive
Growth Fund may acquire options relating to foreign currencies in order to hedge
against changes in exchange rates. The Capital Income Fund and U.S. Government
Securities Fund may each invest up to 5% of its total assets in put options on
portfolio securities, but will do so only to protect against a decline in the
market value of the underlying security.
Options trading is a highly specialized activity which entails greater
than ordinary investment risks. Regardless of how much the market price of the
underlying security, index or currency increases or decreases, the option
buyer's risk is limited to the amount of the original investment for the
purchase of the option. However, options 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. A listed call option for a particular
security or amount of currency gives the purchaser of the option the right to
buy from a clearing corporation, and a writer has the obligation to sell to the
clearing corporation the underlying security or currency amount at the stated
exercise price at any time prior to the expiration of the option, regardless of
the market price of the security or
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<PAGE> 18
currency. The premium paid to the writer is in consideration for undertaking the
obligations under the option contract. A listed put option gives the purchaser
the right to sell to a clearing corporation the underlying security or amount of
currency at the stated exercise price at any time prior 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 a stock 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. As stated in its Prospectus, the U.S. Government Securities Fund may
also engage in unlisted, over-the-counter options. Unlisted options are not
subject to the protection afforded purchasers of options listed by the Options
Clearing Corporation, which performs the obligations of its members who fail to
do so in connection with the purchase or sale of options. Furthermore, it is the
position of the staff of the Securities and Exchange Commission that
over-the-counter options are illiquid. To the extent that a Fund invests in
options that are illiquid (including over-the-counter options), such investment
will be subject to the Fund's fundamental limitations on illiquid securities.
A Fund will continue to receive interest or dividend income on the
securities underlying such puts until they are exercised by the Fund. Any losses
realized by a Fund in connection with its purchase of put options will be
limited to the premiums paid by the Fund for the options plus any transaction
costs. A gain or loss may be wholly or partially offset by a change in the value
of the underlying security which the Fund owns.
The Aggressive Growth, Capital Income, and U.S. Government Securities
Funds are permitted to write call options if they are "covered." In the case of
a call option on a security, the option is "covered" if a Fund owns the security
underlying the call or has an absolute and immediate right to acquire that
security without additional cash consideration (or, if additional cash
consideration is required, cash or cash equivalents in such amount as are held
in a segregated account by its custodian) upon conversion or exchange of other
securities held by it. For a call option on an index, the option is covered if a
Fund maintains with its custodian cash or cash equivalents equal to the contract
value. A call option is also covered if a Fund holds a call on the same security
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 difference is
maintained by the Fund in cash or cash equivalents in a segregated account with
its custodian.
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<PAGE> 19
The principal reason for writing call options on a securities portfolio
is the attempt to realize, through the receipt of premiums, a greater current
return than would be realized on the securities alone. In return for the
premium, the covered option writer gives up the opportunity for profit from a
price increase in the underlying security above the exercise price so long as
his obligation as a writer continues, but retains the risk of loss should the
price of the security decline. Unlike one who owns securities not subject to an
option, the covered option writer has no control over when it may be required to
sell its securities, since it may be assigned an exercise notice at any time
prior to the expiration of its obligation as a writer.
If a Fund desires to sell a particular security from its portfolio on
which it has written an option, the Fund will seek to effect a closing purchase
transaction prior to, or concurrently with, the sale of the security. In order
to close out a covered call option position, a Fund will enter into a "closing
purchase transaction" - the purchase of a call option on a security or stock
index with the same exercise price and expiration date as the call option which
it previously wrote on the same security or index. Closing transactions in
covered call options for the U.S. Government Securities Fund are usually
effected directly with the same broker-dealer that effected the original option
transaction.
When a Fund purchases a put or call option, the premium paid by it is
recorded as an asset of the Fund. When a Fund writes an option, an amount equal
to the net premium (the premium less the commission) received by the Fund is
included in the liability section of the 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 average of the closing bid and asked
prices. If an option purchased by a Fund expires unexercised, the Fund realizes
a loss equal to the premium paid. If a Fund enters into a closing sale
transaction on an option purchased by it, the Fund will realize a gain if the
premium received by it on the closing transaction is more than the premium paid
to purchase the option, or a loss if it is less. Moreover, because increases in
the market price of an option will generally reflect (although not necessarily
in direct proportion) increases in the market price of the underlying security
any loss resulting from a closing purchase transaction is likely to be offset in
whole or in part by appreciation of the underlying security if such security is
owned by the Fund. If an option written by a Fund expires on the stipulated
expiration date or if the Fund 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
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<PAGE> 20
received when the option is sold) and the deferred credit related to such option
will be eliminated. If an option written by a Fund is exercised, the proceeds of
the sale will be increased by the net premium originally received and the Fund
will realize a gain or loss.
As noted previously, there are several risks associated with
transactions in options on securities, currencies and indices. For example,
there are significant differences between the securities, currencies 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 ("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; 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 volume;
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.
A decision as to whether, when and how to use options involves the
exercise of skill and judgment, and even a well-conceived transaction may be
unsuccessful to some degree because of market behavior or unexpected events.
Foreign Investments. The Aggressive Growth Fund may invest up to 20% of
its total assets, either directly, or indirectly through investments in American
Depository Receipts ("ADRs") and closed-end investment companies, in securities
issued by foreign companies wherever organized. The Capital Income Fund may
invest up to 10% of its total assets in Eurodollar Convertible Securities that
are convertible into or exchangeable for foreign equity securities represented
by listed ADRs. Interest and dividends on such Eurodollar securities are payable
in U.S. dollars outside of the United States.
ADRs are receipts issued by an American bank or trust company
evidencing ownership of underlying securities issued by a foreign issuer. ADRs
may be listed on a national securities
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<PAGE> 21
exchange or may trade in the over-the-counter market. ADR prices are denominated
in United States dollars; the underlying security may be denominated in a
foreign currency. The underlying security may be subject to foreign government
taxes which would reduce the yield on such securities.
Investments in foreign securities involve certain inherent risks, such
as political or economic instability of the issuer or the country of issue, the
difficulty of predicting international trade patterns and the possibility of
imposition of exchange controls. Such securities may also be subject to greater
fluctuations in price than securities of domestic corporations. In addition,
there may be less publicly available information about a foreign company than
about a domestic company. Foreign companies generally are not subject to uniform
accounting, auditing and financial reporting standards comparable to those
applicable to domestic companies. Foreign brokerage commissions and custodian
fees are generally higher than in the United States. With respect to certain
foreign countries, there is a possibility of expropriation or confiscatory
taxation, or diplomatic developments which could affect investment in those
countries.
In considering whether to invest in the securities of a foreign
company, Bank of America considers such factors as the characteristics of the
particular company, differences between economic trends and the performance of
securities markets within the U.S. and those within other countries, and also
factors relating to the general economic, governmental and social conditions of
the country or countries where the company is located. The extent to which a
Fund will be invested in foreign companies and ADRs will fluctuate from time to
time within the percentage limits stated above depending on the investment
adviser's assessment of prevailing market, economic and other conditions.
When-Issued Securities, Forward Commitments and Delayed Settlements.
When a Fund agrees to purchase securities on a "when-issued," forward commitment
or delayed settlement basis, its custodian will set aside cash or liquid
portfolio securities equal to the amount of the commitment in a separate
account. Normally, the custodian will set aside portfolio securities to satisfy
a purchase commitment. In such a case, a Fund may be required subsequently to
place additional assets in the separate account in order to assure that the
value of the account remains equal to the amount of the commitment. The Funds do
not intend to engage in these transactions for speculative purposes but only in
furtherance of their investment objectives. Because a Fund will set aside cash
or liquid portfolio securities to satisfy its purchase commitments in the manner
described, its liquidity and the ability of the investment adviser to manage it
may be affected in the event the forward commitments, commitments to
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<PAGE> 22
purchase when-issued securities and delayed settlements ever exceeded 25% of the
value of a Fund's assets.
A Fund will purchase securities on a when-issued, forward commitment or
delayed settlement basis only with the intention of completing the transaction.
If deemed advisable as a matter of investment strategy, however, a Fund may
dispose of or renegotiate a commitment after it is entered into, and may sell
securities it has committed to purchase before those securities are delivered to
the Fund on the settlement date. In these cases the Fund may realize a taxable
capital gain or loss.
When a Fund engages in when-issued, forward commitment and delayed
settlement transactions, it relies on the other party to consummate the trade.
Failure of such party to do so may result in the Fund's incurring a loss or
missing an opportunity to obtain a price considered to be advantageous.
The market value of the securities underlying a when-issued purchase,
forward commitment to purchase securities, or a delayed settlement and any
subsequent fluctuations in their market value is taken into account when
determining the market value of a Fund starting on the day the Fund agrees to
purchase the securities. A Fund does not earn interest on the securities it has
committed to purchase until they are paid for and delivered on the settlement
date.
Securities Lending. The Aggressive Growth, Capital Income and U.S.
Government Securities Funds may lend securities as described in their
Prospectuses. Such loans will be secured by cash or securities of the U.S.
Government and its agencies and instrumentalities, and additionally in the case
of the Aggressive Growth Fund by an irrevocable letter of credit issued by a
U.S. commercial bank that is a member of the Federal Reserve System or the
Federal Deposit Insurance Corporation and has total assets in the excess of $1.5
billion. The collateral must be at all times equal to at least the market value
of the securities loaned. The Fund will continue to receive interest or
dividends on the securities it loans, and will also earn interest on the
investment of any cash collateral. In the case of the Capital Income and U.S.
Government Securities Funds, cash collateral may be invested in short-term U.S.
Government securities, and in the case of the Aggressive Growth Fund cash
collateral may be invested in U.S. Treasury notes, certificates of deposit,
other high-grade, short-term obligations or interest-bearing cash equivalents.
Although voting rights, or rights to consent, attendant to securities loaned
pass to the borrower, such loans may be called at any time and will be called so
that the securities may be noted by a fund if a material event affecting the
investment is to occur.
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<PAGE> 23
ADDITIONAL INFORMATION - CAPITAL INCOME FUND
As described in its Prospectus, the Capital Income Fund's investment
objective is to provide investors with a total investment return, comprised of
current income and capital appreciation, consistent with prudent investment
risk. The Capital Income Fund seeks to achieve this objective by investing in a
diversified portfolio consisting principally of convertible bonds and
convertible preferred stocks. As described in its Prospectus, the Fund may
invest in Eurodollar Convertible Securities, which are fixed income securities
of a U.S. or foreign issuer issued in U.S. dollars outside the United States and
carry certain conversion or exchange features. The interest and dividends on
these Eurodollar Convertibles are payable in U.S. dollars outside the United
States.
The Fund has adopted a fundamental policy that under normal market
conditions it will invest at least 65% of its total assets in Convertible
Securities. The Fund may convert Convertible Securities during periods when
market conditions are unfavorable for their disposition or as a result of
developments such as the issuer's call or a decline in the market liquidity for
such Convertible Securities. The securities obtained upon the conversion may be
retained for temporary periods of not greater than two months after conversion,
and during such periods such securities will be considered to be Convertible
Securities for purposes of complying with this policy. Conversions may also
occur when necessary to permit orderly disposition of the investment (for
example, where a more substantial market exists for the underlying security than
for a relatively thinly traded Convertible Security) or when a Convertible
Security reaches maturity or has been called for redemption.
Convertible Securities entitle the holder to receive interest paid or
accrued on debt or the dividends 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 for the Fund, the investment
adviser will consider, among other factors, its 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
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<PAGE> 24
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 the Fund's portfolio as to issuers;
and whether the securities are rated by Moody's or Standard and Poor's 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 Fund may result from an improvement in the
credit standing of an issuer whose securities are held in the Fund 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
Fund or a general increase in interest rates may be expected to result in
capital depreciation to the Fund.
In general, investments in high yielding fixed-income securities are
subject to a significant risk of a change in the credit rating or financial
condition of the issuing entity. Investments in high yielding fixed-income
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 rated fixed-income securities. Such high
yielding securities generally tend to reflect short-term corporate and market
developments to a greater extent than higher rated securities, which react more
to fluctuations in the general level of interest rates. The Fund seeks to 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
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<PAGE> 25
diversification reduces the effect on the Fund of any single investment, it does
not reduce the overall risk of investing in lower rated securities.
In seeking to attain the investment objective of the Fund, the
investment adviser may consider both the relative risks and potential returns of
higher-rated and lower-rated securities. As a result, the Fund may hold
higher-rated fixed-income securities when the differential in return between
lower-rated and higher-rated securities narrows and the investment adviser
believes that the risk of loss of income and principal may be substantially
reduced with only a relatively small reduction in potential capital appreciation
and yield. The relative proportions of the types of securities in the Fund may
vary from time to time according to the prevailing and projected market and
economic conditions and other factors.
ADDITIONAL INFORMATION - AGGRESSIVE GROWTH FUND
The selection of investments for the Aggressive Growth Fund is the
result of a continuous study of trends in industries and companies, earning
power, growth features and other investment criteria. Fund holdings will consist
primarily of common stocks of companies that the investment adviser expects will
experience above-average growth in earnings and price. Most of these companies
will be smaller-capitalized organizations that have limited product lines,
markets and financial resources and are dependent upon a limited management
group. Examples of possible investments include emerging growth companies
employing new technology, initial public offerings of companies offering high
growth potential, or other corporations offering good potential for high growth
in market value. The securities of smaller companies may be subject to more
abrupt or erratic market movements than larger, more established companies both
because the securities typically are traded in lower volume and because the
issuers typically are subject to a greater degree to changes in earnings and
prospects. The Aggressive Growth Fund's net asset value per share is subject to
rapid substantial fluctuation because greater risk is assumed in order to seek
maximum growth.
Securities owned by the Aggressive Growth Fund may be traded only in
the over-the-counter market or on a regional securities exchange, may be listed
only in the quotation service commonly known as the "pink sheets," and may not
be traded every day or in the volume typical of trading on a national securities
exchange. As a result, the disposition by the Aggressive Growth Fund of
portfolio securities, to meet redemptions or otherwise, may require the Fund to
sell these securities at a discount from market prices, to sell during periods
when such disposition is not desirable, or to make many small sales over a
lengthy period of time.
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<PAGE> 26
ADDITIONAL INFORMATION -- CALIFORNIA TAX-EXEMPT BOND FUND
Municipal Securities. The California Tax-Exempt Bond Fund currently
intends that 65% of its assets will be invested in municipal bonds under
ordinary market conditions. This is not, however, a fundamental investment
policy. As a matter of fundamental policy, under normal market conditions at
least 80% of the Fund's assets will be invested in California Municipal
Securities. The California Tax-Exempt Bond Fund's average weighted maturity will
vary in response to variations in comparative yields of differing maturities of
instruments, in accordance with the Fund's investment objective.
The two principal classifications of Municipal Securities that may be
held by the California Tax-Exempt Bond Fund are "general obligation" securities
and "revenue" securities. General obligation securities are secured by the
issuer's pledge of its full faith, credit and taxing power for the payment of
principal and interest. Revenue securities are payable only from the revenues
derived from a particular facility or class of facilities or, in some cases,
from the proceeds of a special excise tax or other specific revenue source such
as the user of the facility being financed.
Municipal Securities include debt obligations issued to obtain funds
for various public purposes, including the construction of a wide range of
public facilities, the refunding of outstanding obligations, the payment of
general operating expenses and the extension of loans to public institutions and
facilities. In addition, certain types of private activity bonds (including
industrial development bonds under prior law) are issued by or on behalf of
public authorities to finance various privately-operated facilities. Such
obligations are included within the term Municipal Securities if the interest
paid thereon is exempt from regular federal income tax.
The Fund may purchase short-term Tax Anticipation Notes, Bond
Anticipation Notes, Revenue Anticipation Notes and other forms of short-term
tax-exempt loans. Such notes are issued with a short-term maturity in
anticipation of the receipt of tax funds, the proceeds of bond placements or
other revenues. The Fund may also purchase tax-exempt commercial paper.
There are, of course, variations in the quality of Municipal
Securities, both within a particular classification and between classifications,
and the yields on Municipal Securities depend upon a variety of factors,
including general money market conditions, the financial condition of the
issuer, general conditions of the municipal bond market, the size of a
particular offering, the maturity of the obligation and the rating of the issue.
The ratings of Moody's, S&P, Fitch and D&P represent their opinions as to the
credit quality of Municipal Securities.
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<PAGE> 27
It should be emphasized, however, that ratings are general and are not absolute
standards of quality, and Municipal Securities with the same maturity, interest
rate and rating may have different yields while Municipal Securities of the same
maturity and interest rate with different ratings may have the same yield.
Subsequent to its purchase by the Fund, an issue of Municipal Securities may
cease to be rated or its rating may be reduced below the minimum rating required
for purchase by the Fund. The Fund's investment adviser will consider such an
event in determining whether the Fund should continue to hold the obligation. As
stated in the Prospectus, the Fund is permitted to invest a portion of its
assets in non-investment grade securities. For a discussion of the risks
presented by investments in lower-rated fixed income securities, see "Investment
Objectives and Policies - Additional Information - Capital Income Fund" above.
An issuer's obligations under its Municipal Securities are subject to
the provisions of bankruptcy, insolvency and other laws affecting the rights and
remedies of creditors, such as the federal Bankruptcy Code, and laws, if any,
which may be enacted by federal or state legislatures extending the time for
payment of principal or interest, or both, or imposing other constraints upon
enforcement of such obligations. The power or ability of an issuer to meet its
obligations for the payment of interest on, and principal of, its Municipal
Securities may be materially adversely affected by litigation or other
conditions. Further, it should also be noted with respect to all Municipal
Securities issued after August 15, 1986 (August 31, 1986 in the case of certain
bonds), the issuer must comply with certain rules formerly applicable only to
"industrial development bonds" which, if the issuer fails to observe them, could
cause interest on the Municipal Securities to become taxable retroactive to the
date of issue.
Information about the financial condition of issuers of Municipal
Securities may be less available than about corporations a class of whose
securities is registered under the Securities Exchange Act of 1934.
From time to time, proposals have been introduced before Congress for
the purpose of restricting or eliminating the federal income tax exemption for
interest on Municipal Securities. For example, pursuant to federal tax
legislation passed in 1986, interest on certain private activity bonds must be
included in an investor's federal alternative minimum taxable income, and
corporate investors must include all tax-exempt interest in their federal
alternative minimum taxable income. (See the Fund's Prospectus under "MANAGEMENT
OF THE FUND -- Tax Information.") Moreover, with respect to Municipal Securities
issued by the State of California, the Fund cannot predict what legislation, if
any, may be proposed in the California
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Legislature as regards the California State personal income tax status of
interest on such obligations, or which proposals, if any, might be enacted. Such
proposals, while pending or if enacted, might materially adversely affect the
availability of California Municipal Securities, in particular, and Municipal
Securities generally, for investment by the Fund and the liquidity and value of
the Fund. In such an event, the Fund would re-evaluate its investment objective
and policies and consider changes in its structure or possible dissolution.
Stand-By Commitments. The California Tax-Exempt Bond Fund may acquire
"stand-by commitments" with respect to Municipal Securities held in its
portfolio. Under a "stand-by commitment," a dealer agrees to purchase from the
Fund, at the Fund's option, specified Municipal Securities at a specified price.
"Stand-by commitments" acquired by the Fund may also be referred to in this
Statement of Additional Information as "put" options.
The amount payable to the Fund upon its exercise of a "stand-by
commitment" is normally (i) the Fund's acquisition cost of the Municipal
Securities (excluding any accrued interest which the Fund paid on their
acquisition), less any amortized market premium or plus any amortized market or
original issue discount during the period the Fund owned the securities, plus
(ii) all interest accrued on the securities since the last interest payment date
during that period. A "stand-by commitment" may be sold, transferred or assigned
by the Fund only with the instrument involved.
The Fund expects that "stand-by commitments" will generally be
available without the payment of any direct or indirect consideration. However,
if necessary or advisable, the Fund may pay for a "stand-by commitment" either
separately in cash or by paying a higher price for portfolio securities which
are acquired subject to the commitment (thus reducing the yield to maturity
otherwise available for the same securities). The total amount paid in either
manner for outstanding "stand-by commitments" held by the Fund will not exceed
1/2 of 1% of the value of its total assets calculated immediately after each
"stand-by commitment" is acquired.
The Fund intends to enter into "stand-by commitments" only with
dealers, banks and broker-dealers which, in the investment adviser's opinion,
present minimal credit risks. The Fund's reliance upon the credit of these
dealers, banks and broker-dealers is secured by the value of the underlying
Municipal Securities that are subject to a commitment.
The Fund would acquire "stand-by commitments" solely to facilitate
portfolio liquidity and does not intend to exercise its rights thereunder for
trading purposes. The acquisition of a "stand-by commitment" would not affect
the valuation or assumed
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maturity of the underlying Municipal Securities, which would continue to be
valued in accordance with the ordinary method of valuation employed by the Fund.
"Stand-by commitments" which would be acquired by the Fund would be valued at
zero in determining net asset value. Where the Fund paid any consideration
directly or indirectly for a "stand-by commitment," its cost would be reflected
as unrealized depreciation for the period during which the commitment was held
by the Fund.
Custodial Receipts and Participation Interest. Securities acquired by
the Fund may be in the form of custodial receipts evidencing rights to receive a
specific future interest payment, principal payment or both on certain Municipal
Securities. Such obligations are held in custody by a bank on behalf of holders
of the receipts. These custodial receipts are known by various names, including
"Municipal Receipts", "Municipal Certificates of Accrual on Tax-Exempt
Securities" ("M-CATs") and "Municipal Zero-Coupon Receipts." Participation
interests that the Fund may acquire give the Fund an undivided interest in the
security or securities involved. Participation interests may have fixed,
floating or variable rates of interest, and will have remaining maturities of
thirteen months or less as determined in accordance with the regulations of the
Securities and Exchange Commission (although the securities held by the issuer
may have longer maturities). If a participation interest in unrated, the
investment adviser will have determined that the interest is of comparable
quality to those instruments in which the Fund may invest pursuant to guidelines
approved by the Board of Directors. For certain participation interests, the
Fund will have the right to demand payment, on not more than 30 days' notice,
for all or any part of the Fund's participation interest, plus accrued interest.
As to these instruments, the Fund intends to exercise its right to demand
payment as needed to provide liquidity, to maintain or improve the quality of
its investment portfolio or upon a default (if permitted under the terms of the
instrument).
Special Considerations Relating to California Municipal Securities.
ECONOMIC FACTORS. The Governor's 1993-1994 Budget, introduced on
January 8, 1993, proposed general fund expenditures of $37.3 billion, with
projected revenues of $39.9 billion. To balance the budget in the face of
declining revenues, the Governor proposed a series of revenue shifts from local
government, reliance on increased federal aid, and reductions in state spending.
The Department of Finance of the State of California's May Revision of
General Fund Revenues and Expenditures (the "May Revision"), released on May 20,
1993, projected the State would have an accumulated deficit of about $2.75
billion by June 30,
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1993, essentially unchanged from the prior year. The Governor proposed to
eliminate this deficit over an 18-month period. Unlike previous years, the
Governor's Budget and May Revision did not calculate a "gap" to be closed, but
rather set forth revenue and expenditure forecasts and proposals designed to
produce a balanced budget.
The 1993-1994 budget act (the "1993-94 Budget Act") was signed by the
Governor on June 30, 1993, along with implementing legislation. The Governor
vetoed about $71 million in spending.
The 1993-94 Budget Act was predicated on general fund revenues and
transfers estimated at $40.6 billion, $400 million below 1992-93 (and the second
consecutive year of actual decline). The principal reasons for declining revenue
were the continued weak economy and the expiration (or repeal) of three fiscal
steps taken in 1991--a half cent temporary sales tax, a deferral of operating
loss carryforwards, and repeal by initiative of a sales tax on candy and snack
foods.
The 1993-94 Budget Act also assumed special fund revenues of $11.9
billion, an increase of 2.9 percent over 1992-93.
The 1993-94 Budget Act includes general fund expenditures of $38.5
billion (a 6.3 percent reduction from projected 1992-93 expenditures of $41.1
billion), in order to keep a balanced budget within the available revenues. The
1993-94 Budget Act also included special fund expenditures of $12.1 billion, a
4.2 percent increase. The 1993-94 Budget Act reflected the following major
adjustments:
1. Changes in local government financing to shift about $2.6 billion in
property taxes from cities, counties, special districts and redevelopment
agencies to school and community college districts, thereby reducing general
fund support by an equal amount. About $2.5 billion is permanent, reflecting
termination of the State's "bailout" of local governments following the property
tax cuts of Proposition 13 in 1978 (See "Constitutional, Legislative and Other
Factors" below).
The property tax revenue losses for cities and counties were offset in
part by additional sales tax revenues and mandate relief.
2. The 1993-94 Budget Act projected K-12 Proposition 98 funding on a
cash basis at the same per-pupil level as 1992-93 by providing schools a $609
million loan payable from future years' Proposition 98 funds.
3. The 1993-94 Budget Act assumed receipt of about $692 million of aid
to the State from the federal government to
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offset health and welfare costs associated with foreign immigrants living in the
State, which would reduce a like amount of General Fund expenditures. About $411
million of this amount was one-time funding. Congress ultimately appropriated
only $450 million.
4. Reductions of $600 million in health and welfare programs and $400
million in support for higher education (partly offset by fee increases at all
three units of higher education) and various miscellaneous cuts (totalling
approximately $150 million) in State government services in many agencies, up to
15 percent.
5. A 2-year suspension of the renters' tax credit ($390 million
expenditure reduction in 1993-94).
6. Miscellaneous one-time items, including deferral of payment to the
Public Employees Retirement Fund ($339 million) and a change in accounting for
debt service from accrual to cash basis, saving $107 million.
The 1993-94 Budget Act contained no general fund tax/revenue increases
other than a two year suspension of the renters' tax credit. The 1993-1994
Budget Act suspended the 4 percent automatic budget reduction trigger, as was
done in 1992-1993, so cuts could be focused.
Administration reports during the course of the 1993-1994 Fiscal Year
indicated that while economic recovery appeared to have started in the second
half of the fiscal year, recessionary conditions continued longer than had been
anticipated when the 1993-1994 Budget Act was adopted. Overall, revenues for the
1993-1994 Fiscal Year were about $800 million lower than original projections,
and expenditures were about $780 million higher, primarily because of higher
health and welfare caseloads, lower property taxes which required greater State
support for K-14 education to make up the shortfall, and lower than anticipated
federal government payments for immigration-related costs. The reports in May
and June, 1994, indicated that revenues in the second half of the 1993-1994
Fiscal Year have been very close to the projections made in the Governor's
Budget of January 10, 1994, which is consistent with a slow turnaround in the
economy.
The Department of Finance's July 1994 Bulletin, including the final
June receipts, reported that June revenues were $114 million (2.5 percent) above
projection, with final end-of-year results at $377 million (about 1 percent)
above the May Revision projections. Part of this result was due to end-of-year
adjustments and reconciliations. Personal income tax and sales tax continued to
track projections very well. The largest factor in the higher than anticipated
revenues was from bank and
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corporation taxes, which were $140 million (18.4 percent) above projection in
June. While the higher June receipts are reflected in the actual 1993-94 Fiscal
Year cash flow results, and help the starting cash balance for the 1994-95
Fiscal Year, the Department of Finance has not adjusted any of its revenue
projections for the 1994-95 or 1995-96 Fiscal Years.
During the 1993-94 Fiscal Year, the State implemented the deficit
retirement plan, which was part of the 1993-94 Budget Act, by issuing $1.2
billion of revenue anticipation warrants in February 1994 maturing December 21,
1994. This borrowing reduced the cash deficit at the end of the 1993-94 Fiscal
Year. Nevertheless, because of the $1.5 billion variance from the original
1993-94 Budget Act assumptions, the General Fund ended the fiscal year at June
30, 1994 carrying forward an accumulated deficit of approximately $2 billion.
Because of the revenue shortfall and the State's reduced internal
borrowable cash resources, in addition to the $1.2 billion of revenue
anticipation warrants issued as part of the deficit retirement plan, the State
issued an additional $2.0 billion of revenue anticipation warrants, maturing
July 26, 1994, which were needed to fund the State's obligations and expenses
through the end of the 1993-94 Fiscal Year.
On January 17, 1994, a major earthquake measuring an estimated 6.8 on
the Richter Scale struck Los Angeles. Significant property damage to private and
public facilities occurred in a four-county area including northern Los Angeles
County, Ventura County, and parts of Orange and San Bernardino Counties, which
were declared as State and federal disaster areas by January 18. Current
estimates of total property damage (private and public) are in the range of $20
billion, but these estimates are still subject to change.
Despite such damage, on the whole, the vast majority of structures in
the areas, including large manufacturing and commercial buildings and all modern
high-rise offices, survived the earthquake with minimal or no damage, validating
the cumulative effect of strict building codes and thorough preparation for such
an emergency by the State and local agencies.
Damage to state-owned facilities included transportation corridors and
facilities such as Interstate Highways 5 and 10 and State Highways 14, 118 and
210. Major highways have now been reopened. The campus of California State
University at Northridge (very near the epicenter) suffered an estimated $350
million damage, resulting in temporary closure of the campus. It has reopened
using borrowed facilities elsewhere in the area and many temporary structures.
There was also some damage to the University of California at Los Angeles and to
an
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office building in Van Nuys (now open after a temporary closure). Overall,
except for the temporary road and bridge closures, and CSU-Northridge, the
earthquake did not and is not expected to significantly affect State government
operations.
The State in conjunction with the federal government is committed to
providing assistance to local governments, individuals and businesses suffering
damage as a result of the earthquake, as well as to provide for the repair and
replacement of State-owned facilities. The federal government will provide
substantial earthquake assistance.
The President immediately allocated some available disaster funds, and
Congress has approved additional funds for a total of at least $9.5 billion of
federal funds for earthquake relief, including assistance to homeowners and
small businesses, and costs for repair of damaged public facilities. The
Governor originally proposed that the State will have to pay about $1.9 billion
for earthquake relief costs, including a 10 percent match to some of the federal
funds, and costs for some programs not covered by the federal aid. The Governor
proposed to cover $1.05 billion of these costs from a general obligation bond
issue which was on the June 1994 ballot, but it was not approved by the voters.
The Governor subsequently announced that the State's share for transportation
projects would come from existing Department of Transportation funds (thereby
delaying other, non-earthquake related projects), that the State's share for
certain other costs (including local school building repairs) would come from
reallocating existing bond funds, and that a proposed program for homeowner and
small business aid supplemental to federal aid would have to be abandoned. Some
other costs will be borrowed from the federal government in a manner similar to
that used by the State of Florida after Hurricane Andrew; pursuant to Senate
Bill 2383, repayment will have to be addressed in 1995-96 or beyond. The 1995-96
Governor's Budget includes $60 million as the first repayment of an estimated
$121.4 million in loans prior to June 30, 1995.
The 1994-95 Fiscal Year represents the fourth consecutive year the
Governor and Legislature were faced with a very difficult budget environment to
produce a balanced budget. Many program cuts and budgetary adjustments have
already been made in the last three years. The Governor's Budget proposal, as
updated in May and June, 1994, recognized that the accumulated deficit could not
be repaid in one year, and proposed a two-year solution. The budget proposal
sets forth revenue and expenditure forecasts and revenue and expenditure
proposals which result in operating surpluses for the budget for both 1994-95
and 1995-96, and lead to the elimination of the accumulated budget deficit,
estimated at about $1.8 billion at June 30, 1994, by June 30, 1996.
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The 1994-95 Budget Act, signed by the Governor on July 8, 1994,
projects revenues and transfers of $41.9 billion, $2.1 billion higher than
revenues in 1993-94. This reflects the Administration's forecast of an improving
economy. Also included in this figure is a projected receipt of about $360
million from the Federal Government to reimburse the State's cost of
incarcerating undocumented immigrants. The State will not know how much the
Federal Government will actually provide until the Federal FY 1995 Budget is
completed. Completion of the Federal Budget is expected by October 1994. The
Legislature took no action on a proposal in the January 1994-95 Governor's
Budget to undertake an expansion of the transfer of certain programs to
counties, which would also have transferred to counties 0.5% of the State's
current sales tax.
The 1994-95 Budget Act projects Special Fund revenues of $12.1 billion,
a decrease of 2.4% from 1993-94 estimated revenues.
The 1994-95 Budget Act projects General Fund expenditures of $40.9
billion, an increase of $1.6 billion over 1993-94. The 1994-95 Budget Act also
projects Special Fund expenditures of $12.3 billion, a 4.7% decrease from
1993-94 estimated expenditures. The principal features of the 1994-95 Budget Act
were the following:
1. Receipt of additional federal aid in 1994-95 of about $400 million
for costs of refugee assistance and medical care for undocumented
immigrants, thereby offsetting a similar General Fund cost. The State will
not know how much of these funds it will receive until the Federal FY 1995
Budget is passed.
2. Reductions of approximately $1.1 billion in health and welfare
costs. A 2.3% reduction in Aid to Family with Dependent Children payments
(equal to about $56 million for the entire fiscal year) has been suspended
by court order.
3. A General Fund increase of approximately $38 million in support for
the University of California and $65 million for California State
University. It is anticipated that student fees for both the University of
California and the California State University will increase up to 10%.
4. Proposition 98 funding for K-14 schools is increased by $526 million
from 1993-94 levels, representing an increase for enrollment growth and
inflation. Consistent with previous budget agreements, Proposition 98
funding provides approximately $4,217 per student for K-12 schools, equal to
the level in the past three years.
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5. Legislation enacted with the Budget clarifies laws passed in 1992
and 1993 which require counties and other local agencies to transfer funds
to local school districts, thereby reducing State aid. Some counties had
implemented a method of making such transfers which provided less money for
schools if there were redevelopment agency projects. The new legislation
bans this method of transfer. If all counties had implemented this method,
General Fund aid to K-12 schools would have been $300 million higher in each
of the 1994-95 and 1995-96 Fiscal Years.
6. The 1994-95 Budget Act provides funding for anticipated growth in
the State's prison inmate population, including provisions for implementing
recent legislation (the so-called "Three Strikes" law) which requires
mandatory life prison terms for certain third-time felony offenders.
7. Additional miscellaneous cuts ($500 million) and fund transfers
($255 million) totalling in the aggregate approximately $755 million.
The 1994-95 Budget Act contains no tax increases. Under legislation
enacted for the 1993-94 Budget, the renters' tax credit was suspended for two
years (1993 and 1994). A ballot proposition to permanently restore the renters'
tax credit after this year failed at the June, 1994 election. The Legislature
enacted a further one-year suspension of the renters' tax credit, for 1995,
saving about $390 million in the 1995-96 Fiscal Year.
The 1994-95 Budget assumed that the State will use a cash flow
borrowing program in 1994-95 which combines one-year notes and two-year
warrants, which have now been issued. Issuance of warrants allows the State to
defer repayment of approximately $1.0 billion of its accumulated budget deficit
into the 1995-96 Fiscal Year.
The State's cash flow management plan for the 1994-95 fiscal year
included the issuance of $4.0 billion of revenue anticipation warrants on July
26, 1994, to mature on April 25, 1996, as part of a two-year plan to retire the
accumulated State budget deficit.
Because preparation of cash flow estimates for the 1995-96 Fiscal Year
necessarily entails greater risks of variance from assumptions, and because the
Governor's two-year budget plan assumes receipt of a large amount of federal aid
in the 1995-96 Fiscal Year for immigration-related costs which is uncertain, the
Legislature enacted a backup budget adjustment mechanism to mitigate possible
deviations from projected revenues, expenditures or internal borrowable
resources which might reduce available cash resources during the two-year plan,
so as to assure repayment of the warrants.
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Pursuant to Section 12467 of the California Government Code, enacted by
Chapter 135, Statutes of 1994 (the "Budget Adjustment Law"), the State
Controller was required to make a report by November 15, 1994 on whether the
projected cash resources for the General Fund as of June 30, 1995 will decrease
more than $430 million from the amount projected by the State in its official
statement in July, 1994 for the sale of $4,000,000,000 of Revenue Anticipation
Warrants. On November 15, 1994, the State Controller issued the report on the
State's cash position required by the Budget Adjustment Law. The report
indicated that the cash position of the General Fund on June 30, 1995 would be
$581 million better than was estimated in the July, 1994 cash flow projections
and therefore, no budget adjustment procedures will be invoked for the 1994-95
Fiscal Year. As explained earlier, the Law would only be implemented if the
State Controller estimated that borrowable resources on June 30, 1995 would be
at least $430 million lower than projected.
The State Controller's report identified a number of factors which have
led to the improved cash position of the State. Estimated revenues and transfers
for the 1994-95 Fiscal Year other than federal reimbursement for immigration
costs were up about $650 million. The largest portion of this was in higher bank
and corporation tax receipts, but all major tax sources were above original
projections. However, most of the federal immigration aid revenues projected in
connection with the 1994-95 Budget Act and in the July, 1994 cash flows will not
be received, as indicated above, leaving a net increase in revenues of $322
million.
On the expenditure side, the State Controller reported that estimated
reduced caseload growth in health and welfare programs, reduced school
enrollment growth, and an accounting adjustment reducing a transfer from the
General Fund to the Special Fund for Economic Uncertainties resulted in overall
General Fund expenditure reductions (again before adjusting for federal aid) of
$672 million. However, the July, 1994 cash flows projected that General Fund
health and welfare and education expenditures would be offset by the anticipated
receipt of $407 million in federal aid for illegal immigrant costs. The State
Controller now estimates that none of these funds will be received, so the net
reduction in General Fund expenditures is $265 million.
Finally, the State Controller indicated that a review of balances in
special funds available for internal borrowing resulted in an estimated
reduction of such borrowable resources of $6 million. The combination of these
factors results in the estimated improvement of the General Fund's cash position
of $581 million. The State Controller's revised cash flow projections for
1994-95 have allocated this improvement to two line items: an increase from $0
to $427 million in the estimated ending cash
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balance of the General Fund on June 30, 1995, and an increase in unused
borrowable resources of $154 million.
The State Controller's report indicated that there was no anticipated
cash impact in the 1994-95 Fiscal Year for recent initiatives on "three strikes"
criminal penalties and illegal immigration which were approved by voters on
November 8, 1994. At a hearing before a committee of the Legislature on November
15, 1994, both the Legislative Analyst and the Department of Finance concurred
in the reasonableness of the State Controller's report. (The Legislative Analyst
had issued a preliminary analysis on November 1, 1994 which reached a conclusion
very close to that of the State Controller.) The State Controller's report makes
no projections about whether the Law may have to be implemented in 1995-96.
However, both the State Controller and the Legislative Analyst in the November
15 hearing noted that the July, 1994 cash flows for the 1995-96 Fiscal Year
place continued reliance on large amounts of federal assistance for immigration
costs, which did not materialize this year, indicating significant budget
pressures for next year. The Department of Finance indicated that the budgetary
issues identified in the hearing would be addressed in the Governor's Budget
proposal for the 1995-96 Fiscal Year, which will be released in early January,
1995.
The 1995-96 Governor's Budget, discussed below, contains a reforecast
of revenues and expenditures for the 1994-95 Fiscal Year. The Department of
Finance Bulletins for February and March 1995 report that combined General Fund
revenues for February, 1995 were about $356 million below forecast, but combined
revenues for January and February were only about $82 million (or 0.3 percent)
below the 1995-96 Governor's Budget forecast. The largest component of the
decrease is attributable to personal income tax receipts, which were about $131
million (or 1.1 percent) below the two months' forecast. This decrease in
personal income tax receipts appears to be largely attributable to fourth
quarter 1994 activity, probably in the anticipation of tax reform, with some
taxpayers shifting income into 1995 to the extent possible. The withholding
component comprised $77 million of this shortfall, but the Department of Finance
does not yet view this as significant. Additionally, sales and use tax receipts
were very close to forecast for the two-month period, while bank and corporation
tax receipts were about $42 million (or 1.5 percent) below the two months'
forecast. Miscellaneous revenues were about $117 million (or 6.2 percent) above
forecast for the two months, but the Department of Finance is not yet able to
determine whether this gain is real, or is instead attributable to cash flow
factors.
Initial analysis of the federal Fiscal Year 1995 budget by the
Department of Finance indicates that about $98 million was appropriated for
California to offset costs of incarceration of
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undocumented and refugee immigrants, less than the $356 million which was
assumed in the State's 1994-95 Budget Act. Because of timing considerations in
applying for these federal funds, the Department estimates that about $33
million of these funds will be received during the State's 1994-95 Fiscal Year,
with the balance received in the following fiscal year. It does not appear that
the federal budget contains any of the additional $400 million in funding for
refugee assistance and health costs which were also assumed in the 1994-95
Budget Act, but the Department expects the State to continue its efforts to
obtain some or all of these federal funds.
On January 10, 1995, the Governor presented his 1995-96 Fiscal Year
Budget Proposal (the "Proposed Budget"). The Proposed Budget estimates General
Fund revenues and transfers of $42.5 billion (an increase of 0.2 percent over
1994-95). This nominal increase from the 1994-95 Fiscal Year reflects the
Governor's realignment proposal and the first year of his tax cut proposal (see
principal features of the Proposed Budget below for further discussions).
Without these two proposals, General Fund revenues would be projected at
approximately $43.8 billion, or an increase of 3.3 percent over 1994-95.
Expenditures are estimated at $41.7 billion (essentially unchanged from
1994-95). Special Fund revenues are estimated at $13.5 billion (10.7 percent
higher than 1994-95) and Special Fund expenditures are estimated at $13.8
billion (12.2 percent higher than 1994-95). The Proposed Budget projects that
the General Fund will end the fiscal year at June 30, 1996 with a budget surplus
in the Special Fund for Economic Uncertainties of about $92 million, or less
than 1 percent of General Fund expenditures, and will have repaid all of the
accumulated budget deficits.
The following are the principal features of the Proposed Budget:
1. The principal feature of the Proposed Budget is a proposed 15
percent cut in personal income and corporate tax rates, which would be
phased in at 5 percent per year starting in 1996. Existing personal income
tax rates, which are scheduled to drop from 11 percent top rate to 9.3
percent in 1996, would be continued during the time the overall tax cut
takes effect. This proposal would reduce General Fund revenues by $225
million in 1995-96, but the revenue reduction would reach $3.6 billion by
1998-99.
2. The Governor has proposed an expansion of the realignment program
between the State and counties, so that counties will take on greater
responsibility for welfare and social services, while the State will take on
increased funding of trial court costs. The proposal includes transfer of
about $1 billion of State revenues, from sales taxes and trial court funding
moneys, to counties. The net
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effect of the shifts, however, is estimated to save the General Fund about
$240 million.
3. The Governor proposes further cuts in health and welfare costs
totaling about $1.4 billion. Some of these cuts would require federal
legislative approval.
4. Proposition 98 funding for schools and community colleges will
increase by about $1.2 billion, reflecting strong General Fund revenue
growth. Per-pupil expenditures are projected to increase by $61 to $4,292.
For the first time in several years, a cost-of-living increase (2.2 percent)
is added to the enrollment growth factor. The Governor proposes to set aside
about $514 million of the Proposition 98 funding increase to repay prior
years' loans from the General Fund to schools. As the legality of these
loans is currently being challenged in a lawsuit, the Governor proposes to
set the amount aside in escrow until the litigation is resolved.
5. The Proposed Budget includes increases in funding for the University
of California ($63 million General Fund) and the California State University
system ($3 million General Fund). The Governor has proposed a four-year
funding "company" for the higher education units which includes both annual
increases in State funding and increases in student fees.
6. The Proposed Budget assumes receipt of $830 million in new federal
aid for costs of undocumented and refugee immigrants, above commitments
already made by the federal government. This amount is much less than an
estimated $2.8 billion which had been included in the Governor's pro-forma
two-year plan from last summer.
The Proposed Budget contains a cash flow projection (based on all the
assumptions described above) which shows about $1 billion of unused borrowable
resources at June 30, 1996, providing this amount of "cushion" before the budget
"trigger" would have to be invoked.
However, a report issued by the Legislative Analyst in February, 1995
notes that the Proposed Budget is subject to a number of major risks, including
receipt of the expected federal immigration aid and other federal actions to
allow health and welfare costs, and the outcome of several lawsuits concerning
previous budget actions which the State has lost at the trial court level, and
which are under appeal. This Analyst's Report also estimates that, despite more
favorable revenues, the two-year budget estimates made in July, 1994 are about
$2 billion out of balance, principally because federal immigration aid appears
likely to be much lower than previously estimated. This
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shortfall is much smaller than the State has faced in recent years, and has been
addressed in the Governor's Budget.
The Director of Finance is required to include updated cash-flow
statements for the 1994-95 and 1995-96 Fiscal Years in the May revision to the
1995-96 Fiscal Year budget proposal. By June 1, 1995, the State Controller must
concur with these updated statements or provide a revised estimate of the cash
condition of the General Fund for the 1994-95 and the 1995-96 Fiscal Years. For
the 1995-96 Fiscal Year, Chapter 135 prohibits any external borrowing as of June
30, 1996, thereby requiring the State to rely solely on internal borrowable
resources, expenditure reductions or revenue increases to eliminate any
projected cash flow shortfall.
Commencing on October 15, 1995, the State Controller will, in
conjunction with the Legislative Analyst's Office, review the estimated cash
condition of the General Fund for the 1995-96 Fiscal Year. The "1996 cash
shortfall" shall be the amount necessary to bring the balance of unused
borrowable resources on June 30, 1996 to zero. On or before December 1, 1995,
legislation must be enacted providing for sufficient General Fund expenditure
reductions, revenue increases, or both, to offset any such 1996 cash shortfall
identified by the State Controller. If such legislation is not enacted, within
five days thereafter the Director of Finance must reduce all General Fund
appropriations for the 1995-96 Fiscal Year, except the Required Appropriations,
by the percentage equal to the ratio of said 1996 cash shortfall to total
remaining General Fund appropriations for the 1995-96 Fiscal Year, excluding the
Required Appropriations.
On December 6, 1994, Orange County, California and its Investment Pool
(the "Pool") filed for bankruptcy under Chapter 9 of the United States
Bankruptcy Code. Approximately 187 California public entities, substantially all
of which are public agencies within the County, invested funds in the Pool. Many
of the agencies have various bonds, notes or other forms of indebtedness
outstanding, in some instances the proceeds of which were invested in the Pool.
Various investment advisors were employed by the County to restructure the Pool.
Such restructuring led to the sale of substantially all of the Pool's portfolio,
resulting in losses estimated to be approximately $1.7 billion or approximately
22% of amounts deposited by the Pool investors, including the County. It is
anticipated that such losses may result in delays or failures of the County as
well as investors in the Pool to make scheduled debt service payments. Further,
the County expects substantial budget deficits to occur in Fiscal Year 1995 with
possibly similar effects upon operations of investors in the Pool.
Investor access to monies in the Pool subsequent to the filing was
pursuant to Court order only and severely limited. On
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May 2, 1995, the Bankruptcy Court approved a comprehensive settlement agreement
(the "CSA") between the County and Pool investors which, among other things, (i)
established a formula for distribution of all available cash and securities from
the Pool to the Pool investors, including the County, (ii) established formulas
for distribution among certain settling Pool investors of several tranches of
new County obligations to be payable from, and in some instances secured by,
certain designated sources of potential recoveries on Pool related claims, and
(iii) designated certain outstanding short term note obligations of the County
to be senior to or on a parity with certain of the new County obligations. By
order dated May 22, 1995, following distribution of all available cash and
securities from the Pool to the Pool investors, including the County, the
Bankruptcy Court dismissed the bankruptcy filing of the Pool based upon the
Court's finding that the Pool was not eligible for relief under Chapter 9 of the
Bankruptcy Code because it is not a municipality and it has not been
specifically authorized to file under Chapter 9 as required by the Bankruptcy
Code.
Following its bankruptcy filing, the County has, with Bankruptcy Court
approval, made payments of scheduled principal and interest on its outstanding
obligations where no alternative source of payment (such as reserve funds on
deposit with indenture trustees, letters of credit, municipal bond insurance
policies or other alternative payment sources) were available. The County has
not replenished such reserve funds or reimbursed the issuers of such letters of
credit or municipal bond insurance policies. In addition, the County ceased
making set aside deposits for repayment of certain of its short term
indebtedness. The Bankruptcy Court subsequently ruled that the rights of the
holders of such short term indebtedness to require the set aside deposits from
County revenues received following the filing were cut off by operation of the
Bankruptcy Code. In addition, the County has failed to satisfy its obligation to
accept tenders of its $110,200,000 aggregate principal amount of Taxable Pension
Obligation Bonds, Series B used to finance County pension obligations. Interest
at a rate set pursuant to the bond documents has been timely paid on such
Pension Bonds. The failure to satisfy the contractual obligations discussed
above may constitute defaults under the documents governing such securities.
To June 30, 1995 there has been no default in payment of scheduled
interest and principal (excluding the tender payment described above) to holders
of County securities, although certain note issues are scheduled to mature at
various times thereafter and the Fund is unable to predict whether or to what
extent such notes will be timely paid by the County. On June 27, 1995, the
Bankruptcy Court approved a Stipulation and an Extension Agreement that, if they
both become effective, would offer to holders of certain short term note
obligations of the
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County ("Note Debt") who elect to be treated thereunder: (i) extension of
maturity dates to June 30, 1996; (ii) payment of monthly interest at a rate
below existing contract rates; (iii) accrual of monthly interest equal to the
difference between the amount paid and the contract rate, plus a settlement
adjustment of 0.95%; (iv) waiver of post-bankruptcy interest recapture or
disallowance; (v) waiver of defenses to repayment of the Note Debt claims based
on California limitations on municipal indebtedness; and (vi) allowance of the
Note Debt claims, subject to certain reserved rights. The treatment described in
the preceding sentence will be available to electing holders of Note Debt
provided that holders of at least 50% of the then issued and outstanding
aggregate principal amount of all Note Debt obligations elect such treatment. If
holders of at least 90% of the outstanding aggregate principal amount of all
Note Debt obligations elect such treatment, all of the Note Debt obligations
will be so treated. The Fund is unable to predict whether and to what extent
holders of Note Debt will elect to be treated under the Extension Agreement.
On June 27, 1995, the voters of Orange County rejected, by a
substantial majority of those voting, an increase of 0.50% in the sales tax
imposed throughout the County. Prior to the election, spokespersons for the
County had indicated that passage of the sales tax increase was an important
factor in the County's ability to restructure its finances in a manner that
would permit eventual payment in full of all County securities. The Fund is
unable to predict the effect of the defeat of the sales tax increase on the
ability of the County to restructure its obligations and otherwise manage its
affairs.
Both Standard & Poor's and Moody's Investors Service have suspended or
downgraded ratings on various debt securities of the County and certain of the
investors in the Pool and, following the defeat of the proposition submitted to
the voters on June 27, announced their intention to downgrade the County's debt
to default status, regardless of whether the Stipulation and Extension Agreement
receives approval by holders of the Note Debt. Such suspensions or downgradings
could affect both price and liquidity of such securities. The Fund is unable to
predict (i) the occurrence of covenant and/or payment defaults with respect to
obligations of the County and/or investors in the Pool or (ii) the financial
impact of any such defaults or credit rating suspensions or downgradings upon
the value of such securities.
As of the date of this Statement of Additional Information, the
California Tax-Exempt Bond Fund had investments issued by Orange County,
California totalling approximately 3% of its total assets as of this date. None
of these investments had failed to meet a scheduled interest payment and none of
these investments were obligations payable from the Pool.
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Constitutional, Legislative and Other Factors. Certain California
constitutional amendments, legislative measures, executive orders,
administrative regulations and voter initiatives could result in the adverse
effects described below. The following information constitutes only a brief
summary, does not purport to be a complete description, and is based on
information drawn from official statements and prospectuses relating to
securities offerings of the State of California and various local agencies in
California, available as of the date of the Prospectus and this Statement of
Additional Information. While the Company has not independently verified such
information, it has no reason to believe that such information is not correct in
all material respects.
Certain California Municipal Securities in the Fund may be obligations
of issuers which rely in whole or in part on California State revenues for
payment of these obligations. Property tax revenues and a portion of the State's
general fund surplus are distributed to counties, cities and their various
taxing entities and the State assumes certain obligations theretofore paid out
of local funds. Whether and to what extent a portion of the State's general fund
will be distributed in the future to counties, cities and their various
entities, is unclear.
In 1988, California enacted legislation providing for a water's-edge
combined reporting method if an election fee was paid and other conditions met.
On October 6, 1993, California Governor Pete Wilson signed Senate Bill 671
(Alquist) which modifies the unitary tax law by deleting the requirements that a
taxpayer electing to determine its income on a water's-edge basis pay a fee and
file a domestic disclosure spreadsheet and instead requiring an annual
information return. Significantly, the Franchise Tax Board can no longer
disregard a taxpayer's election. The Franchise Tax Board is reported to have
estimated state revenue losses from the Legislation as growing from $27 million
in 1993-94 to $616 million in 1999-2000, but others, including Assembly Speaker
Willie Brown, disagree with that estimate and assert that more revenue will be
generated for California, rather than less, because of an anticipated increase
in economic activity and additional revenue generated by the incentives in the
Legislation.
Certain California Municipal Securities in the Fund may be obligations
of issuers who rely in whole or in part on ad valorem real property taxes as a
source of revenue. On June 6, 1978, California voters approved an amendment to
the California Constitution known as Proposition 13, which added Article XIIIA
to the California Constitution. The effect of Article XIIIA is to limit ad
valorem taxes on real property and to restrict the ability of taxing entities to
increase real property tax revenues. On November 7, 1978, California voters
approved
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Proposition 8, and on June 3, 1986, California voters approved Proposition 46,
both of which amended Article XIIIA.
Section 1 of Article XIIIA limits the maximum ad valorem tax on real
property to 1% of full cash value (as defined in Section 2), to be collected by
the counties and apportioned according to law; provided that the 1% limitation
does not apply to ad valorem taxes or special assessments to pay the interest
and redemption charges on (i) any indebtedness approved by the voters prior to
July 1, 1978, or (ii) any bonded indebtedness for the acquisition or improvement
of real property approved on or after July 1, 1978, by two-thirds of the votes
cast by the voters voting on the proposition. Section 2 of Article XIIIA defines
"full cash value" to mean "the County Assessor's valuation of real property as
shown on the 1975/76 tax bill under 'full cash value' or, thereafter, the
appraised value of real property when purchased, newly constructed, or a change
in ownership has occurred after the 1975 assessment." The full cash value may be
adjusted annually to reflect inflation at a rate not to exceed 2% per year, or
reduction in the consumer price index or comparable local data, or reduced in
the event of declining property value caused by damage, destruction or other
factors. The California State Board of Equalization has adopted regulations,
binding on county assessors, interpreting the meaning of "change in ownership"
and "new construction" for purposes of determining full cash value of property
under Article XIIIA.
Legislation enacted by the California Legislature to implement Article
XIIIA (Statutes of 1978, Chapter 292, as amended) provides that notwithstanding
any other law, local agencies may not levy any ad valorem property tax except to
pay debt service on indebtedness approved by the voters prior to July 1, 1978,
and that each county will levy the maximum tax permitted by Article XIIIA of
$4.00 per $100 assessed valuation (based on the former practice of using 25%,
instead of 100%, of full cash value as the assessed value for tax purposes). The
legislation further provided that, for the 1978/79 fiscal year only, the tax
levied by each county was to be apportioned among all taxing agencies within the
county in proportion to their average share of taxes levied in certain previous
years. The apportionment of property taxes for fiscal years after 1978/79 has
been revised pursuant to Statutes of 1979, Chapter 282 which provides relief
funds from State moneys beginning in fiscal year 1979/80 and is designed to
provide a permanent system for sharing State taxes and budget funds with local
agencies. Under Chapter 282, cities and counties receive more of the remaining
property tax revenues collected under Proposition 13 instead of direct State
aid. School districts receive a correspondingly reduced amount of property
taxes, but receive compensation directly from the State and are given additional
relief. Chapter 282 does not affect the derivation of the base levy ($4.00 per
$100 assessed valuation) and the bonded debt tax rate.
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On November 6, 1979, an initiative known as "Proposition 4" or the
"Gann Initiative" was approved by the California voters, which added Article
XIIIB to the California Constitution. Under Article XIIIB, State and local
governmental entities have an annual "appropriations limit" and are not allowed
to spend certain moneys called "appropriations subject to limitation" in an
amount higher than the "appropriations limit." Article XIIIB does not affect the
appropriation of moneys which are excluded from the definition of
"appropriations subject to limitation," including debt service on indebtedness
existing or authorized as of January 1, 1979, or bonded indebtedness
subsequently approved by the voters. In general terms, the "appropriations
limit" is required to be based on certain 1978/79 expenditures, and is to be
adjusted annually to reflect changes in consumer prices, population and certain
services provided by these entities. Article XIIIB also provides that if these
entities' revenues in any year exceed the amounts permitted to be spent, the
excess is to be returned by revising tax rates or fee schedules over the
subsequent two years.
At the November 8, 1988 general election, California voters approved an
initiative known as Proposition 98. This initiative amends Article XIIIB to
require that (i) the California Legislature establish a prudent state reserve
fund in an amount as it shall deem reasonable and necessary and (ii) revenues in
excess of amounts permitted to be spent and which would otherwise be returned
pursuant to Article XIIIB by revision of tax rates or fee schedules, be
transferred and allocated (up to a maximum of 4%) to the State School Fund and
be expended solely for purposes of instructional improvement and accountability.
No such transfer or allocation of funds will be required if certain designated
state officials determine that annual student expenditures and class size meet
certain criteria as set forth in Proposition 98. Any funds allocated to the
State School Fund shall cause the appropriation limits established in Article
XIIIB to be annually increased for any such allocation made in the prior year.
Proposition 98 also amends Article XVI to require that the State of
California provide a minimum level of funding for public schools and community
colleges. Commencing with the 1988- 89 fiscal year, state monies to support
school districts and community college districts shall equal or exceed the
lesser of (i) an amount equalling the percentage of state general revenue bonds
for school and community college districts in fiscal year 1986-87, or (ii) an
amount equal to the prior year's state general fund proceeds of taxes
appropriated under Article XIIIB plus allocated proceeds of local taxes, after
adjustment under Article XIIIB. The initiative permits the enactment of
legislation, by a two-thirds vote, to suspend the minimum funding requirement
for one year.
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On June 30, 1989, the California Legislature enacted Senate
Constitutional Amendment 1, a proposed modification of the California
Constitution to alter the spending limit and the education funding provisions of
Proposition 98. Senate Constitutional Amendment 1, on the June 5, 1990 ballot as
Proposition 111, was approved by the voters and took effect on July 1, 1990.
Among a number of important provisions, Proposition 111 recalculates spending
limits for the State and for local governments, allows greater annual increases
in the limits, allows the averaging of two years' tax revenues before requiring
action regarding excess tax revenues, reduces the amount of the funding
guarantee in recession years for school districts and community college
districts (but with a floor of 40.9 percent of State general fund tax revenues),
removes the provision of Proposition 98 which included excess moneys transferred
to school districts and community college districts in the base calculation for
the next year, limits the amount of State tax revenue over the limit which would
be transferred to school districts and community college districts, and exempts
increased gasoline taxes and truck weight fees from the State appropriations
limit. Additionally, Proposition 111 exempts from the State appropriations limit
funding for capital outlays.
Article XIIIB, like Article XIIIA, may require further interpretation
by both the Legislature and the courts to determine its applicability to
specific situations involving the State and local taxing authorities. Depending
upon the interpretation, Article XIIIB may limit significantly a governmental
entity's ability to budget sufficient funds to meet debt service on bonds and
other obligations.
On November 4, 1986, California voters approved an initiative statute
known as Proposition 62. This initiative (i) requires that any tax for general
governmental purposes imposed by local governments be approved by resolution or
ordinance adopted by a two-thirds vote of the governmental entity's legislative
body and by a majority vote of the electorate of the governmental entity, (ii)
requires that any special tax (defined as taxes levied for other than general
governmental purposes) imposed by a local governmental entity be approved by a
two-thirds vote of the voters within that jurisdiction, (iii) restricts the use
of revenues from a special tax to the purposes or for the service for which the
special tax was imposed, (iv) prohibits the imposition of ad valorem taxes on
real property by local governmental entities except as permitted by Article
XIIIA, (v) prohibits the imposition of transaction taxes and sales taxes on the
sale of real property by local governments, (vi) requires that any tax imposed
by a local government on or after August 1, 1985 be ratified by a majority vote
of the electorate within two years of the adoption of the initiative or be
terminated by November 15, 1988, (vii) requires that, in the event a local
government fails to comply with the provisions of this measure, a
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reduction in the amount of property tax revenue allocated to such local
government occurs in an amount equal to the revenues received by such entity
attributable to the tax levied in violation of the initiative, and (viii)
permits these provisions to be amended exclusively by the voters of the State of
California.
In September 1988, the California Court of Appeal in City of
Westminster v. County of Orange, 204 Cal. App. 3d 623, 215 Cal. Rptr. 511 (Cal.
Ct. App. 1988), held that Proposition 62 is unconstitutional to the extent that
it requires a general tax by a general law city, enacted on or after August 1,
1985 and prior to the effective date of Proposition 62, to be subject to
approval by a majority of voters. The Court held that the California
Constitution prohibits the imposition of a requirement that local tax measures
be submitted to the electorate by either referendum or initiative. It is not
possible to predict the impact of this decision on charter cities, on special
taxes or on new taxes imposed after the effective date of Proposition 62.
On November 8, 1988, California voters approved Proposition 87.
Proposition 87 amended Article XVI, Section 16, of the California Constitution
by authorizing the California Legislature to prohibit redevelopment agencies
from receiving any of the property tax revenue raised by increased property tax
rates levied to repay bonded indebtedness of local governments which is approved
by voters on or after January 1, 1989. It is not possible to predict whether the
California Legislature will enact such a prohibition nor is it possible to
predict the impact of Proposition 87 on redevelopment agencies and their ability
to make payments on outstanding debt obligations.
Certain California Municipal Securities in the Fund may be obligations
which are payable solely from the revenues of health care institutions. Certain
provisions under California law may adversely affect these revenues and,
consequently, payment on those Municipal Securities.
The Federally sponsored Medicaid program for health care services to
eligible welfare beneficiaries in California is known as the Medi-Cal program.
Historically, the Medi-Cal program has provided for a cost-based system of
reimbursement for inpatient care furnished to Medi-Cal beneficiaries by any
hospital wanting to participate in the Medi-Cal program, provided such hospital
met applicable requirements for participation. California law now provides that
the State of California shall selectively contract with hospitals to provide
acute inpatient services to Medi-Cal patients. Medi-Cal contracts currently
apply only to acute inpatient services. Generally, such selective contracting is
made on a flat per diem payment basis for all services to Medi-Cal
beneficiaries, and generally such payment has not increased in relation to
inflation, costs or
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<PAGE> 48
other factors. Other reductions or limitations may be imposed on payment for
services rendered to Medi-Cal beneficiaries in the future.
Under this approach, in most geographical areas of California, only
those hospitals which enter into a Medi-Cal contract with the State of
California will be paid for non-emergency acute inpatient services rendered to
Medi-Cal beneficiaries. The State may also terminate these contracts without
notice under certain circumstances and is obligated to make contractual payments
only to the extent the California legislature appropriates adequate funding
therefor.
California enacted legislation in 1982 that authorizes private health
plans and insurers to contract directly with hospitals for services to
beneficiaries on negotiated terms. Some insurers have introduced plans known as
"preferred provider organizations" ("PPOs"), which offer financial incentives
for subscribers who use only the hospitals which contract with the plan. Under
an exclusive provider plan, which includes most health maintenance organizations
("HMOs"), private payors limit coverage to those services provided by selected
hospitals. Discounts offered to HMOs and PPOs may result in payment to the
contracting hospital of less than actual cost and the volume of patients
directed to a hospital under an HMO or PPO contract may vary significantly from
projections. Often, HMO or PPO contracts are enforceable for a stated term,
regardless of provider losses or of bankruptcy of the respective HMO or PPO. It
is expected that failure to execute and maintain such PPO and HMO contracts
would reduce a hospital's patient base or gross revenues. Conversely,
participation may maintain or increase the patient base, but may result in
reduced payment and lower net income to the contracting hospitals.
These California Municipal Securities may also be insured by the State
of California pursuant to an insurance program implemented by the Office of
Statewide Health Planning and Development for health facility construction
loans. If a default occurs on insured California Municipal Securities, the State
Treasurer will issue debentures payable out of a reserve fund established under
the insurance program or will pay principal and interest on an unaccelerated
basis from unappropriated State funds. At the request of the Office of Statewide
Health Planning and Development, Arthur D. Little, Inc. prepared a study in
December 1983, to evaluate the adequacy of the reserve fund established under
the insurance program and based on certain formulations and assumptions found
the reserve fund substantially underfunded. In September of 1986, Arthur D.
Little, Inc. prepared an update of the study and concluded that an additional
10% reserve be established for "multi-level" facilities. For the balance of the
reserve fund, the update recommended maintaining the current reserve calculation
method.
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In March of 1990, Arthur D. Little, Inc. prepared a further review of the study
and recommended that separate reserves continue to be established for
"multi-level" facilities at a reserve level consistent with those that would be
required by an insurance company.
Certain California Municipal Securities in the Fund may be obligations
which are secured in whole or in part by a mortgage or deed of trust on real
property. California has five principal statutory provisions which limit the
remedies of a creditor secured by a mortgage or deed of trust. Two limit the
creditor's right to obtain a deficiency judgment, one limitation being based on
the method of foreclosure and the other on the type of debt secured. Under the
former, a deficiency judgment is barred when the foreclosure is accomplished by
means of a nonjudicial trustee's sale. Under the latter, a deficiency judgment
is barred when the foreclosed mortgage or deed of trust secures certain purchase
money obligations. Another California statute, commonly known as the "one form
of action" rule, requires creditors secured by real property to exhaust their
real property security by foreclosure before bringing a personal action against
the debtor. The fourth statutory provision limits any deficiency judgment
obtained by a creditor secured by real property following a judicial sale of
such property to the excess of the outstanding debt over the fair value of the
property at the time of the sale, thus preventing the creditor from obtaining a
large deficiency judgment against the debtor as the result of low bids at a
judicial sale. The fifth statutory provision gives the debtor the right to
redeem the real property from any judicial foreclosure sale as to which a
deficiency judgement may be ordered against the debtor.
Upon the default of a mortgage or deed of trust with respect to
California real property, the creditor's nonjudicial foreclosure rights under
the power of sale contained in the mortgage or deed of trust are subject to the
constraints imposed by California law upon transfers of title to real property
by private power of sale. During the three-month period beginning with the
filing of a formal notice of default, the debtor is entitled to reinstate the
mortgage by making any overdue payments. Under standard loan servicing
procedures, the filing of the formal notice of default does not occur unless at
least three full monthly payments have become due and remain unpaid. The power
of sale is exercised by posting and publishing a notice of sale for at least 20
days after expiration of the three-month reinstatement period. Therefore, the
effective minimum period for foreclosing on a mortgage could be in excess of
seven months after the initial default. Such time delays in collections could
disrupt the flow of revenues available to an issuer for the payment of debt
service on the outstanding obligations if such defaults occur with respect to a
substantial number of mortgages or deeds of trust securing an issuer's
obligations.
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In addition, a court could find that there is sufficient involvement of
the issuer in the nonjudicial sale of property securing a mortgage for such
private sale to constitute "state action," and could hold that the
private-right-of-sale proceedings violate the due process requirements of the
Federal or State Constitutions, consequently preventing an issuer from using the
nonjudicial foreclosure remedy described above.
Certain California Municipal Securities in the Fund may be obligations
which finance the acquisition of single family home mortgages for low and
moderate income mortgagors. These obligations may be payable solely from
revenues derived from the home mortgages, and are subject to California's
statutory limitations described above applicable to obligations secured by real
property. Under California antideficiency legislation, there is no personal
recourse against a mortgagor of a single family residence purchased with the
loan secured by the mortgage, regardless of whether the creditor chooses
judicial or nonjudicial foreclosure.
Under California law, mortgage loans secured by single-family
owner-occupied dwellings may be prepaid at any time. Prepayment charges on such
mortgage loans may be imposed only with respect to voluntary prepayments made
during the first five years during the term of the mortgage loan, and cannot in
any event exceed six months' advance interest on the amount prepaid in excess of
20% of the original principal amount of the mortgage loan. This limitation could
affect the flow of revenues available to an issuer for debt service on the
outstanding debt obligations which financed such home mortgages.
Other Investment Information. The investment adviser believes that it
is likely that sufficient California Municipal Securities will be available to
satisfy the investment objective, policies and limitations of the California
Tax-Exempt Bond Fund, and to enable the Fund to invest at least 50% of its total
assets in California Municipal Securities at the close of each of its fiscal
quarters. In meeting this investment policy the Fund may invest in Municipal
Securities which are private activity bonds (including industrial development
bonds under prior law) the interest on which is subject to the 26% to 28%
federal alternative minimum tax applicable to individuals and the 20% federal
alternative minimum tax and the environmental tax applicable to corporations.
The environmental tax applicable to corporations is imposed at the rate of .12%
on the excess of the corporations modified federal alternative minimum taxable
income over $2,000,000. Investments in such securities, however, will not exceed
under normal market conditions 20% of the Fund's total assets when added
together with any taxable investments held by the Fund. Moreover, although the
Fund does not presently intend to do so on a regular basis, it may invest more
than 25% of its assets in Municipal Securities the interest on which is paid
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solely from revenues of similar projects if such investment is deemed necessary
or appropriate by the Fund's investment adviser in light of the Fund's
investment objective and policies. To the extent that the Fund's assets are
concentrated in Municipal Securities payable from revenues on similar projects,
the Fund will be subject to the peculiar risks presented by such projects to a
greater extent than it would be if the Fund's assets were not so concentrated.
If the Company's Board of Directors, after consultation with the
investment adviser, should for any reason determine that it is impracticable to
invest at least 50% of the Fund's total assets in California Municipal
Securities at the close of each quarter of the Fund's taxable year, the Board
would re-evaluate the Fund's investment objective and policies and consider
changes in its structure and name or possible dissolution.
OTHER INVESTMENT LIMITATIONS
The Fund's investment objectives are fundamental; the prospectus for
each Fund summarizes certain other fundamental policies that may not be changed
with respect to such Fund without the affirmative vote of the holders of the
majority of the Fund's outstanding shares (as defined below under "Additional
Information - Miscellaneous"). Similarly, the following enumerated additional
fundamental policies, as well as the Fund's investment objectives, may not be
changed with respect to each Fund without such a vote of shareholders.
THE AGGRESSIVE GROWTH FUND MAY NOT:
1. Purchase or sell real estate (however, the Fund may, to the extent
appropriate to its investment objective, purchase securities issued by companies
investing in real estate or interests therein).
2. Underwrite the securities of other issuers.
3. Purchase securities of companies for the purpose of exercising
control.
4. Purchase securities on margin, make short sales of securities or
maintain a short position, except that this limitation shall not apply to
transactions in futures contracts and related options.
5. Acquire any other investment company or investment company security
except in connection with a merger, consolidation, reorganization or acquisition
of assets or as may otherwise be permitted by the Investment Company Act of
1940.
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6. Purchase securities of any one issuer (other than obligations issued
or guaranteed by U.S. Government, its agencies or instrumentalities) if
immediately thereafter more than 15% of its total assets would be invested in
certificates of deposit or bankers' acceptances of any one bank, or more than 5%
of its total assets would be invested in other securities of any one bank or the
securities of any other issuer (except that up to 25% of the Fund's total assets
may be invested without regard to this limitation).
In accordance with current regulations of the Securities and Exchange
Commission, the Aggressive Growth Fund presently intends to limit its
investments in the securities of any single issuer to not more than 5% of its
total assets (measured at the time of purchase), except that up to 25% of the
Fund's total assets may be invested without regard to this limitation. This
intention is not, however, a fundamental policy of the Fund.
7. Purchase any securities which would cause 25% or more of the Fund's
total assets at the time of purchase to be invested in the securities of one or
more issuers conducting their principal business activities in the same
industry, provided that (a) there is no limitation with respect to obligations
issued or guaranteed by the U.S. Government, its agencies or instrumentalities;
(b) wholly-owned finance companies will be considered to be in the industries of
their parents if their activities are primarily related to financing the
activities of the parents; and (c) the industry classification of utilities will
be determined according to their service. For example, gas, gas transmission,
electric and gas, electric and telephone will be considered a separate industry.
8. Borrow money or issue senior securities, except that the Fund may
borrow from banks or enter into reverse repurchase agreements to meet
redemptions or for other temporary purposes in amounts up to 10% of its total
assets at the time of such borrowing; or mortgage, pledge or hypothecate any
assets except in connection with any such borrowing and in amounts not in excess
of the lesser of the dollar amounts borrowed or 10% of its total assets at the
time of such borrowing; or purchase securities at any time after such borrowings
(including reverse repurchase agreements) have been entered into and before they
are repaid. The Fund's transactions in futures and related options (including
the margin posted by the Fund in connection with such transactions) are not
subject to this investment limitation.
9. Make loans except that the fund may purchase or hold debt
instruments or enter into repurchase agreements pursuant to its investment
objective and policies and my lend portfolio securities in an amount not
exceeding 30% of its total assets.
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<PAGE> 53
10. Purchase securities without available market quotations which
cannot be sold without registration or the filing of a notification under
Federal or state securities laws, enter into repurchase agreements providing for
settlement more than seven days after notice, or purchase any other securities
deemed illiquid by the Directors if, as a result, such securities and repurchase
agreements would exceed 10% of the Funds total value.
The Fund intends that variable amount master demand notes with
maturities of nine months or less, as well as any investments in securities that
are not registered under the 1933 Act but that may be purchased by institutional
buyers under Rule 144A and for which a liquid trading market exists as
determined by the Board of Directors or Bank of America (pursuant to guidelines
adopted by the Board), will not be subject to this 10% limitation or illiquid
securities.
11. Purchase or sell commodity contracts, or invest in oil, gas or
mineral exploration or development programs, except that the Fund may, to the
extent appropriate to its investment objective, purchase publicly traded
securities of companies engaging in whole or in part in such activities, and may
enter into futures contract and related options.
THE U.S. GOVERNMENT SECURITIES FUND AND CAPITAL INCOME FUND MAY NOT:
1. Purchase the securities of any issuer if as a result more than 5% of
the value of the Fund's total assets would be invested in the securities of such
issuer, except that up to 25% of the value of the Fund's total assets may be
invested without regard to this 5% limitation. Securities issued or guaranteed
by the United States Government or its agencies or instrumentalities are not
subject to this investment limitation.
2. Underwrite any issue of securities, except to the extent that the
purchase of securities directly from the issuer thereof in accordance with the
Fund's investment objective, policies and limitations may be deemed to be
underwriting.
3. Purchase or sell real estate, except that a Fund may, to the extent
appropriate to its investment objective, invest in GNMA Certificates and
securities issued by companies which invest in real estate or interests therein.
4. Purchase securities on margin (except for such short-term credits as
may be necessary for the clearance of transactions), make short sales of
securities or maintain a short position.
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5. Write or sell puts, calls, straddles, spreads or combinations
thereof, except that the Funds may write covered call options.
6. Purchase or sell commodities or commodity contracts, or invest in
oil, gas or mineral exploration or development programs, except that: (a) a Fund
may, to the extent appropriate to its investment objective, invest in securities
issued by companies which purchase or sell commodities or commodity contracts or
which invest in such programs; and (b) a Fund may purchase and sell futures
contracts and options on futures contracts.
7. Purchase securities of other investment companies, except (a)
securities of money-market funds, to the extent permitted by the Investment
Company Act of 1940, or (b) in connection with a merger, consolidation,
acquisition or reorganization.
8. Purchase any securities which would cause 25% or more of the value
of its total assets at the time of such purchase to be invested in the
securities of one or more issuers conducting their principal business activities
in the same industry; provided, however, that (a) there is no limitation with
respect to investments in obligations issued or guaranteed by the federal
government and its agencies and instrumentalities; (b) each utility (such as
gas, gas transmission, electric and telephone service) will be considered a
single industry for purposes of this policy; and (c) wholly-owned finance
companies will be considered to be in the industries of their parents if their
activities are primarily related to financing the activities of their parents.
9. Purchase securities of any issuer if as a result the Fund will own
more than 10% of the voting securities of such issuer.
10. Purchase any securities which would cause 25% or more of the value
of its total assets at the time of such purchase to be invested in the
securities of one or more issuers conducting their principal business activities
in the same industry; provided, however, that (a) there is no limitation with
respect to investments in obligations issued or guaranteed by the federal
government and its agencies and instrumentalities (b) each utility (such as gas,
gas transmission, electric and telephone service) will be considered a single
industry for purposes of this policy; and (c) wholly-owned finance companies
will be considered to be in the industries of their parents if their activities
are primarily related to financing the activities of their parents.
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11. Borrow money except from banks for temporary purposes and in an
amount not exceeding 10% of the value of the Fund's total assets, issue senior
securities (as defined in the Investment Company Act of 1940) or mortgage,
pledge or hypothecate any assets except in connection with any such borrowing
and in amounts not in excess of the lesser of the dollar amounts borrowed or 10%
of the value of the Fund's total assets at the time of such borrowing. Borrowing
may take the form of sale of portfolio securities accompanied by a simultaneous
agreement as to their repurchase. (This borrowing provision is not for
investment leverage, but solely to facilitate management of the Fund's portfolio
by enabling the Fund to meet redemption requests when the liquidation of
portfolio securities is deemed to be disadvantageous or inconvenient. The Fund
will not purchase any securities while borrowing are outstanding. Interest paid
on borrowed funds will reduce the net investment income of the Fund.) For the
purpose of this restriction, collateral or escrow arrangements with respect to
margin for futures contracts are not deemed to be a pledge of assets, and
neither such arrangements nor the purchase of futures contracts are deemed to be
the issuance of a senior security.
12. Make loans, except that the Fund may purchase or hold debt
obligations in accordance with its investment objective, policies and
limitations; may enter into repurchase agreements with respect to securities;
and may lend portfolio securities against collateral consisting of cash or
securities of the U.S. Government and its agencies and its agencies and
instrumentalities which are consistent with its permitted investments.
13. Invest more than 10% of the value of its total assets in securities
with legal or contractual restrictions on resale (including repurchase
agreements with terms greater than seven days over the counter options and the
securities covering such options.)
The Fund intends that investments in securities that are not registered
under the 1933 Act but may be purchased by institutional buyers under Rule 144A
and for which a liquid trading market exists as determined by the Board of
Directors or Bank of America (pursuant to guidelines adopted by the Board), will
not be subject to this 10% limitation on illiquid securities.
14. Purchase securities of any issuer which has been in continuous
operation for less than three years (including operations of its predecessors),
except obligations issued or guaranteed by the U.S. government or its agencies.
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IN ADDITION:
1. Under normal market conditions the U.S. Government Securities Fund
may not invest less than 65% of its total assets in GNMA Certificates.
2. Under normal market conditions the Capital Income Fund may not
invest less than 65% of its total assets in Convertible Securities. For purposes
of this limitation, securities acquired upon the conversion of Convertible
Securities are deemed to be Convertible Securities for a period of two months
after the effective date of their conversion.
THE CALIFORNIA TAX-EXEMPT BOND FUND MAY NOT:
1. Make loans except that the Fund may purchase or hold debt
instruments and enter into repurchase agreements pursuant to its investment
objective and policies.
2. Purchase or sell real estate (however, the Fund may, to the extent
appropriate to its investment objective, purchase Municipal Securities secured
by real estate or interests therein or securities issued by companies investing
in real estate or interests therein).
3. Purchase securities on margin, make short sales of securities or
maintain a short position.
4. Underwrite the securities of other issuers.
5. Purchase securities of companies for the purpose of exercising
control.
6. Invest in industrial revenue bonds where the payment of principal
and interest are the responsibility of a company (including its predecessors)
with less than three years of continuous operation.
7. Purchase or sell commodity contracts, or invest in oil, gas or
mineral exploration or development programs (however, the Fund may, to the
extent appropriate to its investment objective, purchase publicly traded
securities of companies engaging in whole or in part in such activities).
8. Acquire any other investment company or investment company security
except in connection with a merger, consolidation, reorganization or acquisition
of assets.
9. Purchase securities while its borrowings (including reverse
repurchase agreements) are outstanding.
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<PAGE> 57
10. Purchase securities of any one issuer (other than obligations
issued or guaranteed by the U.S. Government, its agencies or instrumentalities)
if immediately thereafter more than 15% of its total assets would be invested in
certificates of deposit or bankers' acceptances of any one bank, or more than 5%
of its total assets would be invested in other securities of any one bank or the
securities of any other issuer (except that up to 25% of the Fund's total assets
may be invested without regard to this limitation).
11. Purchase any securities which would cause 25% or more of the Fund's
total assets at the time of purchase to be invested in the securities of one or
more issuers conducting their principal business activities in the same
industry, provided that this limitation shall not apply to Municipal Securities
or governmental guarantees of Municipal Securities; and provided, further, that
for the purpose of this limitation only, industrial development bonds that are
backed only by the assets and revenues of a nongovernmental user shall not be
deemed to be Municipal Securities.
12. Borrow money or issue senior securities, except that the Fund may
borrow from banks or enter into reverse repurchase agreements to meet
redemptions or for other temporary purposes in amounts up to 10% of its total
assets at the time of such borrowing; or mortgage, pledge or hypothecate any
assets except in connection with any such borrowing and in amounts not in excess
of the lesser of the dollar amounts borrowed or 10% of its total assets at the
time of such borrowing.
13. Write or sell puts, calls, straddles, spreads, or combinations
thereof except that the Fund may acquire stand-by commitments with respect to
its Municipal Securities.
14. Invest more than 10% of its total assets in securities with legal
or contractual restrictions on resale or for which no readily available market
exists, including repurchase agreements providing for settlement more than seven
days after notice.
In accordance with current regulations of the Securities and Exchange
Commission, the California Tax-Exempt Bond Fund presently intends to limit its
investments in the securities of any single issuer to not more than 5% of its
total assets (measured at the time of purchase), except that up to 25% of the
Fund's total assets may be invested without regard to this limitation. This
intention is not, however, a fundamental policy of the Fund.
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* * *
If a percentage restriction is satisfied at the time of investment, a
later increase or decrease in such percentage resulting from a change in asset
value will not constitute a violation of such restriction.
For the purposes of Investment Limitation Paragraph 1 in the Aggressive
Growth and California Tax-Exempt Bond Funds' Prospectuses, Investment Limitation
Paragraph 2 in the Capital Income Fund's Prospectus, and Investment Limitation
Paragraph 8 in this Statement of Additional Information with respect to the
U.S. Government Securities Fund, the Funds treat, in accordance with the
current views of the staff of the Securities and Exchange Commission and as a
matter of non-fundamental policy that may be changed without a vote of
shareholders, all supranational organizations as a single industry and each
foreign government (and all of its agencies) as a separate industry.
In order to permit the sale of a Fund's shares in certain states, the
Company may make commitments more restrictive than the investment policies and
limitations described above. To permit the sale of the shares of the Capital
Income Fund and Aggressive Growth Fund in Texas, the Company has agreed to the
following additional restrictions with respect to such Funds:
1. The Funds will not invest more than 5% of their net assets in
warrants, of which not more than 2% may be warrants which are not listed on the
New York or American Stock Exchange.
2. The Funds will not invest in oil, gas or mineral leases.
3. The Funds will not invest more than 10% of their respective total
assets in illiquid securities including securities of foreign issuers which are
not listed on a recognized domestic or foreign securities exchange.
Should the Company determine that the above commitments or any other
commitment made to permit the sale of a Fund's shares in any state are no longer
in the best interests of the Fund, it will revoke the commitment by terminating
sales of the Fund's shares in the state involved.
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION
Information on how to purchase and redeem Fund shares, and how such
shares are priced, is included in the Prospectuses. Additional information is
contained below.
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<PAGE> 59
VALUATION OF AGGRESSIVE GROWTH FUND
Portfolio securities are valued at the last sales price on the
securities exchange on which such securities are primarily traded or at the last
sales price obtained from the NASDAQ. Securities not listed on an exchange or
NASDAQ, or securities for which there were no transactions, are valued at the
average of the most recent bid and asked prices. Restricted securities,
securities for which market quotations are not readily available, and other
assets are valued at fair value, using methods determined under the supervision
of the Board of the Company. Valuation of options is described above under
"Investment Objectives and Policies--Options Trading." Short-term securities are
valued at amortized cost, which approximates market value. The amortized cost
method involves valuing a security at its cost on the date of purchase and
thereafter assuming a constant amortization to maturity of the difference
between the principal amount due at maturity and cost.
VALUATION OF CALIFORNIA TAX-EXEMPT BOND FUND
The Fund's assets are valued for purposes of pricing sales and
redemptions by an independent pricing service ("Service") approved by the
Company's Board of Directors. When, in the judgment of the Service, quoted bid
prices for portfolio securities are readily available and are representative of
the bid side of the market, these investments are valued at the mean between
quoted bid prices (as obtained by the Service from dealers in such securities)
and asked prices (as calculated by the Service based upon its evaluation of the
market for such securities). Other investments (which constitute a majority of
the Fund's securities) are carried at fair value as determined by the Service,
based on methods which include consideration of yields or prices of municipal
bonds of comparable quality, coupon, maturity and type; indications as to values
from dealers; and general market conditions. The Service may also employ
electronic data processing techniques and matrix systems to determine value.
Short-term securities are valued at amortized cost, which approximates market
value. The amortized cost method involves valuing a security at its cost on the
date of purchase and thereafter assuming a constant amortization to maturity of
the difference between the principal amount due at maturity and cost.
VALUATION OF CAPITAL INCOME FUND AND U.S. GOVERNMENT SECURITIES FUND
Portfolio securities for which market quotations are readily available
(other than debt securities with remaining maturities of 60 days or less) are
valued at the last reported sale price or (if none is available) the mean
between the current quoted bid and asked prices provided by investment dealers.
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<PAGE> 60
Other securities and assets for which market quotations are not readily
available are valued at their fair value using methods determined under the
supervision of the Board of the Company. Debt securities with remaining
maturities of 60 days or less are valued on an amortized cost basis unless the
Board determines that such basis does not represent fair value at the time.
Under this method such securities are valued initially at cost on the date of
purchase or, in the case of securities purchased with more than 60 days to
maturity, are valued at their market or fair value each day until the 61st day
prior to maturity. Thereafter, absent unusual circumstances, a constant
proportionate amortization of any discount or premium is assumed until maturity
of the security.
A pricing service may be used to value certain portfolio securities
where the prices provided are believed to reflect the fair value of such
securities. In valuing securities the pricing service would normally take into
consideration such factors as yield, risk, quality, maturity, type of issue,
trading characteristics, special circumstances and other factors it deems
relevant in determining valuations for normal institutional-sized trading units
of debt securities and would not rely solely on quoted prices. The methods used
by the pricing service and the valuations so established will be utilized under
the general supervision of the Board. Valuation of options is described above
under "Investment Objectives and Policies - Options Trading".
SUPPLEMENTARY PURCHASE INFORMATION
For the purpose of applying the Right of Accumulation or Letter of
Intent privileges described in the Prospectuses, the scale of sales loads
applies to purchases made by any "purchaser," which term includes an individual
and/or spouse purchasing securities for his, her or their own account or for the
account of any minor children; or a trustee or other fiduciary account
(including a pension, profit-sharing or other employee benefit trust created
pursuant to a plan qualified under Section 401 of the Internal Revenue Code)
although more than one beneficiary is involved; or "a qualified group" which has
been in existence for more than six months and has not been organized for the
purpose of buying redeemable securities of a registered investment company at a
discount, provided that the purchases are made through a central administrator
or a single dealer, or by other means which result in economy of sales effort or
expense. A "qualified group" must have more than 10 members, must be available
to arrange for group meetings between representatives of the Funds and the
members, and must be able to arrange for mailings to members at reduced or no
cost to the Distributor. The value of shares eligible for the Right of
Accumulation privilege may also be used as a credit toward completion of the
Letter of Intent privilege. Such shares will be valued at their
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offering price prevailing on the date of submission of the Letter of Intent.
Distributions on shares held in escrow pursuant to the Letter of Intent
privilege will be credited to the shareholder, but such shares are not eligible
for a Fund's Exchange Privilege.
The computation of the hypothetical offering price per share for each
Fund based on the value of each Fund's net assets on February 28, 1995 and each
Fund's outstanding securities on such dates is as follows:
<TABLE>
<CAPTION>
U.S.
California Aggressive Government Capital
Tax-Exempt Growth Securities Income
Bond Fund Fund Fund Fund
---------- ---------- ---------- -------
<S> <C> <C> <C> <C>
Net Assets........... $194,600,802 $131,878,800 $87,354,230 $198,250,954
Outstanding
Securities.......... 27,334,647 6,398,371 9,382,386 14,529,185
Net Asset Value
Per Share........... $7.12 $20.61 $9.31 $13.65
Sales Charge,
4.50 percent
of offering
price (4.71
percent of net
asset value
per share).......... $0.34 $ 0.97 $0.44 $ 0.64
Offering
to Public........... $7.46 $21.58 $9.75 $14.29
</TABLE>
SUPPLEMENTARY REDEMPTION INFORMATION: CAPITAL INCOME FUND, U.S. GOVERNMENT
SECURITIES FUND AND CALIFORNIA TAX-EXEMPT BOND FUND
Shares in the Capital Income Fund, U.S. Government Securities Fund and
California Tax-Exempt Bond Fund for which orders for wire redemption are
received on a business day before the close of regular trading hours on the New
York Stock Exchange (currently 4:00 p.m. (Eastern Time)) will be redeemed as of
the close of regular trading hours on such Exchange and the proceeds of
redemption (less any applicable contingent deferred sales charge imposed on
shareholders who purchased shares of a Fund of $1 million or more without a
front-end sales load and redeem such shares within 2 years after purchase)
will normally be wired in federal funds on the next business day to the
commercial bank specified by the investor on the Account Application (or
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<PAGE> 62
other bank of record on the investor's file with the Transfer Agent). To qualify
to use the wire redemption privilege, the payment for Fund shares must be drawn
on, and redemption proceeds paid to, the same bank and account as designated on
the Account Application (or other bank of record as described above). If the
proceeds of a particular redemption are to be wired to another bank, the request
must be in writing and signature guaranteed. Shares for which orders for wire
redemption are received after the close of regular trading hours on the New York
Stock Exchange or on a non-business day will be redeemed as of the close of
trading on such Exchange on the next day on which shares of the particular Fund
are priced and the proceeds (less any applicable contingent deferred sales
charge imposed on shareholders who purchased shares of a Fund of $1 million or
more without a front-end sales load and redeem such shares within 2 years after
purchase) will normally be wired in federal funds on the next business day
thereafter. Redemption proceeds (less any applicable contingent deferred sales
charge imposed on shareholders who purchased shares of a Fund of $1 million or
more without a front-end sales load and redeem such shares within 2 years after
purchase) will be wired to a correspondent member bank if the investor's
designated bank is not a member of the Federal Reserve System. Immediate
notification by the correspondent bank to the investor's bank is necessary to
avoid a delay in crediting the funds to the investor's bank account. Proceeds of
less than $1,000 will be mailed to the investor's address.
To change the commercial bank or account designated to receive
redemption proceeds, a written request must be sent to the Company, c/o Pacific
Horizon Funds, Inc., P.O. Box 80221, Los Angeles, California 90080-9909. Such
request must be signed by each shareholder, with each signature guaranteed as
described in the Funds' Prospectuses. Guarantees must be signed by an authorized
signatory and "signature guaranteed" must appear with the signature. The
Transfer Agent may request further documentation from corporations, executors,
administrators, trustees or guardians, and will accept other suitable
verification arrangements from foreign investors, such as consular verification.
Investors in the U.S. Government Securities Fund and California
Tax-Exempt Bond Fund redeeming by Check generally will be subject to the same
rules and regulations that commercial banks apply to checking accounts, although
the election of this privilege creates only a shareholder-transfer agent
relationship with the Transfer Agent. An investor may deliver Checks directly to
the Transfer Agent, BISYS Fund Services Ohio, Inc., 3435 Stelzer Road, Columbus,
Ohio 43219-3035, in which case the proceeds will be mailed, wired or made
available at the Transfer Agent on the next business day. The Check delivered to
the Transfer Agent must be accompanied by a properly executed stock
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<PAGE> 63
power form on which the investor's signature is guaranteed as described in the
Funds' Prospectuses.
Because dividends on the U.S. Government Securities Fund and California
Tax-Exempt Bond Fund accrue daily, Checks should not be used to close an account
as a small balance is likely to result.
Check redemption may be modified or terminated at any time by the
Company or the Transfer Agent upon notice to shareholders.
SUPPLEMENTARY PURCHASE AND REDEMPTION INFORMATION: ALL FUNDS
In General. As described in the Prospectuses, Fund shares may be
purchased directly by the public, by clients of Bank of America through their
qualified trust and agency accounts, or by clients of securities dealers,
financial institutions (including banks) and other industry professionals, such
as investment advisers, accountants and estate planning firms that have entered
into service and/or selling agreements with the Distributor. (The Distributor,
such institutions and professionals are collectively referred to as "Service
Organizations.") Bank of America and Service Organizations may impose minimum
customer account and other requirements in addition to those imposed by the Fund
and described in the respective Prospectuses. Purchase orders will be effected
only on business days.
Shares in each Fund are sold with a sales load. However, there is no
front-end sales load on combined purchases of shares of $1 million or more.
Concord Financial Group, Inc. will pay commissions of up to 1.00% to brokers
whose customers purchase such shares. Additionally, a 1.00% and 0.50%
contingent deferred sales charge is applicable to shareholders who purchase
shares of a Fund of $1 million or more without a front-end sales load and
redeem such shares within one year and two years, respectively, after purchase.
Service Organizations may be paid by the Distributor at the Company's expense
for shareholder services. Depending on the terms of the particular account, Bank
of America, its affiliates, and Service Organizations also may charge their
customers fees for automatic investment, redemption and other services provided.
Such fees may include, for example, account maintenance fees, compensating
balance requirements or fees based upon account transactions, assets or income.
Bank of America or the particular Service Organization is responsible for
providing information concerning these services and any charges to any customer
who must authorize the purchase of Fund shares prior to such purchase.
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<PAGE> 64
Persons wishing to purchase Company shares through their accounts at
Bank of America or a Service Organization should contact such entity directly
for appropriate instructions.
Initial purchases of shares into a new account may not be made by wire.
However, persons wishing to make a subsequent purchase of Company shares into an
already existing account by wire should telephone the Transfer Agent at (800)
346-2087. The investor's bank must be instructed to wire federal funds to the
Transfer Agent, referring in the wire to the particular Fund in which such
investment is to be made; the investor's portfolio account number; and the
investor's name.
The Transfer Agent may charge a fee to act as Custodian for IRAs,
payment of which could require the liquidation of shares. All fees charged are
described in the appropriate form. Shares may be purchased in connection with
these plans only by direct remittance to the Transfer Agent. Purchases for IRA
accounts will be effective only when payments received by the Transfer Agent are
converted into federal funds. Purchases for these plans may not be made in
advance of receipt of funds.
For processing redemptions, the Transfer Agent may request further
documentation from corporations, executors, administrators, trustees or
guardians. The Transfer Agent will accept other suitable verification
arrangements from foreign investors, such as consular verification.
Investors should be aware that if they have selected the TeleTrade
Privilege, any request for a wire redemption will be effected as a TeleTrade
transaction through the Automated Clearing House (ACH) system unless more prompt
transmittal is specifically requested. Redemption proceeds of a TeleTrade
transaction will be on deposit in the investor's account at the ACH member bank
normally two business days after receipt of the redemption request.
Exchange Privilege. Shareholders in the Pacific Horizon Family of Funds
have an exchange privilege whereby they may exchange all or part of their
Pacific Horizon Shares for shares of other investment portfolios in the Pacific
Horizon Family of Funds. Shareholders may also exchange all or a part of their
Pacific Horizon Shares for like shares of an investment portfolio of Time
Horizon Funds. By use of the exchange privilege, the investor authorizes the
Transfer Agent to act on telephonic, telegraphic or written exchange
instructions from any person representing himself or herself to be the investor
and believed by the Transfer Agent to be genuine. The Transfer Agent's records
of such instructions are binding. The exchange privilege may be modified or
terminated at any time upon notice to shareholders. For federal income tax
purposes, exchange transactions are treated as sales on which a purchaser will
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<PAGE> 65
realize a capital gain or loss depending on whether the value of the shares
exchanged is more or less than his basis in such shares at the time of the
transaction.
Exchange transactions described in Paragraphs A, B, C and D below will
be made on the basis of the relative net asset values per share of the
investment portfolios involved in the transaction.
A. Shares of any investment portfolio purchased with a sales load, as well
as additional shares acquired through reinvestment of dividends or
distributions on such shares, may be exchanged without a sales load for
shares of any other investment portfolio in the Pacific Horizon Family
of Funds or the Time Horizon Funds.
B. Shares of any investment portfolio in the Pacific Horizon Family of
Funds or the Time Horizon Funds acquired by a previous exchange
transaction involving shares on which a sales load has directly or
indirectly been paid (e.g. shares purchased with a sales load or issued
in connection with an exchange transaction involving shares that had
been purchased with a sales load), as well as additional shares
acquired through reinvestment of dividends or distributions on such
shares, may be redeemed and the proceeds used to purchase without a
sales load shares of any other investment portfolio. To accomplish an
exchange transaction under the provisions of this Paragraph, investors
must notify the Transfer Agent of their prior ownership of shares and
their account number.
C. Shares of any investment portfolio in the Pacific Horizon Family of
Funds may be exchanged without a sales load for shares of any other
investment portfolio in the Family that is offered without a sales
load.
D. Shares of any investment portfolio in the Pacific Horizon Family of
Funds purchased without a sales load may be exchanged without a sales
load for shares in any other portfolio where the investor involved
maintained an account in the Pacific Horizon Family of Funds before
April 20, 1987 or was the beneficial owner of shares of Bunker Hill
Income Securities, Inc. on the date of its reorganization into the
Pacific Horizon Corporate Bond Fund.
Neither a contingent deferred sales charge nor a front-end sales load
will be imposed at the time of exchange if a shareholder purchases shares of a
Fund of $1 million or more without a front-end sales load and exchanges such
shares for shares of another investment portfolio of the Company or Time Horizon
Funds. However, shares acquired in the exchange are subject to a contingent
deferred sales charge of 1.00% and 0.50%, respectively, on redemptions within
one year and two years after purchase.
Except as stated above, a sales load will be imposed when shares of any
investment portfolio in the Pacific Horizon Family of Funds that were purchased
or otherwise acquired without a sales load are exchanged for shares of another
investment
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<PAGE> 66
portfolio in the Pacific Horizon Family or the Time Horizon Funds which are sold
with a sales load.
Exchange requests received on a business day prior to the time shares
of the investment portfolios involved in the request are priced will be
processed on the date of receipt. "Processing" a request means that shares in
the investment portfolio from which the shareholder is withdrawing an investment
will be redeemed at the net asset value per share next determined on the date of
receipt. Shares of the new investment portfolio into which the shareholder is
investing will also normally be purchased at the net asset value per share next
determined coincident to or after the time of redemption. Exchange requests
received on a business day after the time shares of the investment portfolios
involved in the request are priced will be processed on the next business day in
the manner described above.
Miscellaneous. Certificates for shares will not be issued.
Depending on the terms of the customer account at Bank of America or a
Service Organization, certain purchasers may arrange with the Company's
custodian for sub-accounting services paid by the Company without direct charge
to the purchaser.
A "business day" for purposes of processing share purchases and
redemptions received by the Transfer Agent at its Columbus office is a day on
which the New York Stock Exchange is open for trading. In 1996, the scheduled
holidays on which the New York Stock Exchange is closed are: New Year's Day,
Presidents' Day, Good Friday, Memorial Day (observed), Independence Day, Labor
Day, Thanksgiving Day and Christmas Day.
The Company may suspend the right of redemption or postpone the date of
payment for shares during any period when (a) trading on the New York Stock
Exchange is restricted by applicable rules and regulations of the Securities and
Exchange Commission; (b) the New York Stock Exchange is closed for other than
customary weekend and holiday closings; (c) the Securities and Exchange
Commission has by order permitted such suspension; or (d) an emergency exists as
determined by the Securities and Exchange Commission. (The Company may also
suspend or postpone the recordation of the transfer of its shares upon the
occurrence of any of the foregoing conditions.)
The Company's Charter permits its Board of Directors to require a
shareholder to redeem involuntarily shares in a Fund if the balance held of
record by the shareholder drops below $500 and such shareholder does not
increase such balance to $500 or more upon 60 days' notice. The Company will not
require a shareholder to redeem shares of a Fund if the balance held of record
by the shareholder is less than $500 solely because of a
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<PAGE> 67
decline in the net asset value of the Fund's shares. The Company may also redeem
shares involuntarily if such redemption is appropriate to carry out the
Company's responsibilities under the 1940 Act.
If the Company's Board of Directors determines that conditions exist
which make payment of redemption proceeds wholly in cash unwise or undesirable,
the Company may make payment wholly or partly in securities or other property.
In such an event, a shareholder would incur transaction costs in selling the
securities or other property. The Company has committed that it will pay all
redemption requests by a shareholder of record in cash, limited in amount with
respect to each shareholder during any ninety-day period to the lesser of
$250,000 or 1% of the net asset value at the beginning of such period.
ADDITIONAL INFORMATION CONCERNING TAXES
FEDERAL - ALL FUNDS
Each Fund will be treated as a separate corporate entity under the
Internal Revenue Code of 1986, as amended (the "Code"), and intends to qualify
as a "regulated investment company." By following this policy, each Fund expects
to eliminate or reduce to a nominal amount the federal income taxes to which it
may be subject. If for any taxable year a Fund of the Company does not qualify
for the special federal tax treatment afforded regulated investment companies,
all of the Fund's taxable income would be subject to tax at regular corporate
rates (without any deduction for distributions to shareholders). In such event,
the Fund's dividend distributions (including amounts derived from interest on
Municipal Securities in the case of the California Tax-Exempt Bond Fund) to
shareholders would be taxable as ordinary income to the extent of the current
and accumulated earnings and profits of the particular Fund and would be
eligible for the dividends received deduction in the case of corporate
shareholders.
Qualification as a regulated investment company under the Code
requires, among other things, that each Fund distribute to its shareholders an
amount equal to at least the sum of 90% of its investment company taxable income
(if any) and 90% of its tax-exempt income (if any) net of certain deductions for
each taxable year. In general, a Fund's investment company taxable income will
be its taxable income, subject to certain adjustments and excluding the excess
of any net long-term capital gain for the taxable year over the net short-term
capital loss, if any, for such year. Each Fund of the Company intends to
distribute virtually all of its investment company taxable income (if any) for
each taxable year. To the extent such income is distributed by a Fund (whether
in cash or additional shares), it will be taxable to shareholders as ordinary
income.
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<PAGE> 68
A Fund will not be treated as a regulated investment company under the
Code if 30% or more of the Fund's gross income for a taxable year is derived
from gains realized on the sale or other disposition of the following
investments held for less than three months (the "short-short test"): (1) stock
and securities (as defined in section 2(a)(36) of the 1940 Act); (2) options,
futures and forward contracts other than those on foreign currencies; and (3)
foreign currencies (and options, futures and forward contracts on foreign
currencies) that are not directly related to a Fund's principal business of
investing in stock and securities (and options and futures with respect to
stocks and securities). Interest (including original issue discount and accrued
market discount) received by a Fund upon maturity or disposition of a security
held for less than three months will not be treated as gross income derived from
the sale or other disposition of such security within the meaning of this
requirement. However, any other income which is attributable to realized market
appreciation will be treated as gross income from the sale or other disposition
of securities for this purpose. With respect to covered call options, if the
call is exercised by the holder, the premium and the price received on exercise
constitute the proceeds of sale, and the difference between the proceeds and the
cost of the securities subject to the call is capital gain or loss. Premiums
from expired call options written by a Fund and net gains from closing purchase
transactions are treated as short-term capital gains for federal income tax
purposes, and losses on closing purchase transactions are short-term capital
losses. See Appendix B -- "Accounting and Tax Treatment" -- for a general
discussion of the federal tax treatment of futures contracts, related options
thereon and other financial instruments, including their treatment under the
short- short test.
Any distribution of the excess of net long-term capital gains over net
short-term capital losses is taxable to shareholders as long-term capital gains,
regardless of how long the shareholder has held the distributing Fund's shares
and whether such gains are received in cash or additional Fund shares. The Fund
will designate such a distribution as a capital gain dividend in a written
notice mailed to shareholders after the close of the Fund's taxable year. It
should be noted that, upon the sale or exchange of Fund shares, if the
shareholder has not held such shares for more than six months, any loss on the
sale or exchange of those shares will be treated as long-term capital loss to
the extent of the capital gain dividends received with respect to the shares.
Ordinary income of individuals is taxable at a maximum nominal rate of
39.6%, but because of limitations on itemized deductions otherwise allowable and
the phase-out of personal exemptions, the maximum effective marginal rate of tax
for some taxpayers may be higher. An individual's long-term capital gains
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<PAGE> 69
are taxable at a maximum nominal rate of 28%. For corporations, long-term
capital gains and ordinary income are both taxable at a maximum nominal rate of
35% (or at a maximum effective marginal rate of 39% in the case of corporations
having taxable income between $100,000 and $335,000).
A 4% non-deductible excise tax is imposed on regulated investment
companies that fail to currently distribute specified percentages of their
ordinary taxable income and capital gain net income (excess of capital gains
over capital losses). Each Fund intends to make sufficient distributions or
deemed distributions of its ordinary taxable income and any capital gain net
income prior to the end of each calendar year to avoid liability for this excise
tax.
The Company 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 upon sale paid to shareholders who (i) have failed to provide either a
correct tax identification number in the manner provided, (ii) who are subject
to withholding by the Internal Revenue Service for failure to properly include
on their return payments of taxable interest or dividends or (iii) who have
failed to certify to the Company that they are subject to backup withholding
when required to do so or that they are "exempt recipients."
FEDERAL - CALIFORNIA TAX-EXEMPT BOND FUND
The Fund's policy is to pay each year as exempt- interest dividends
substantially all the Fund's Municipal Securities interest income net of certain
deductions. An exempt- interest dividend is any dividend or part thereof (other
than a capital gain dividend) paid by the Fund and designated as an
exempt-interest dividend in a written notice mailed to shareholders after the
close of the Fund's taxable year. However, the aggregate amount of dividends so
designated by the Fund cannot exceed the excess of the amount of interest exempt
from tax under Section 103 of the Code received by the Fund during the taxable
year over any amounts disallowed as deductions under Sections 265 and 171(a)(2)
of the Code. The percentage of total dividends paid for any taxable year which
qualifies as exempt-interest dividends will be the same for all shareholders
receiving dividends from the Fund for such year. In order for the California
Tax-Exempt Bond Fund to pay exempt-interest dividends for any taxable year, at
the close of each quarter of its taxable year at least 50% of the aggregate
value of the Fund's assets must consist of exempt-interest obligations.
Exempt-interest dividends may be treated by shareholders of the
California Tax-Exempt Bond Fund as items of interest excludable from their gross
income under Section 103(a) of the Code. However, each shareholder is advised to
consult his
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<PAGE> 70
or her tax adviser with respect to whether exempt-interest dividends would
retain the exclusion under Section 103(a) if such shareholder would be treated
as a "substantial user" or a "related person" to such user with respect to
facilities financed through any of the tax-exempt obligations held by the Fund.
A "substantial user" is defined under U.S. Treasury Regulations to include a
non-exempt person who regularly uses a part of such facilities in his or her
trade or business and whose gross revenues derived with respect to the
facilities financed by the issuance of bonds are more than 5% of the total
revenues derived by all users of such facilities, or who occupies more than 5%
of the usable area of such facilities or for whom such facilities or a part
thereof were specifically constructed, reconstructed or acquired. A "related
person" includes certain related natural persons, affiliated corporations,
partners and partnerships and S corporations and their shareholders.
Interest on indebtedness incurred by a shareholder to purchase or carry
shares generally is not deductible for federal income tax purposes. In addition,
if a shareholder holds Fund shares for six months or less, any loss on the sale
or exchange of those shares will be disallowed to the extent of the amount of
exempt-interest dividends received with respect to the shares. The Treasury
Department, however, is authorized to issue regulations reducing the six months
holding requirement to a period of not less than the greater of 31 days or the
period between regular dividend distributions where the investment company
regularly distributes at least 90% of its net tax-exempt interest. No such
regulations had been issued as of the date of this Statement of Additional
Information.
As discussed in the Prospectus for the California Tax- Exempt Bond
Fund, dividends attributable to interest on certain private activity bonds
issued after August 7, 1986 must be included by shareholders as an item of tax
preference for purposes of determining possible liability for the Federal
alternative minimum tax and the environmental tax applicable to corporations.
The alternative minimum tax rate for individuals is 26-28% and for corporations
is 20%. The environmental tax applicable to corporations is imposed at the rate
of .12% on the excess of the corporation's modified alternative minimum taxable
income over $2,000,000.
Income itself exempt from federal income taxation may be considered in
addition to adjusted gross income when determining whether Social Security
payments received by a shareholder are subject to federal income taxation.
STATE - CALIFORNIA TAX-EXEMPT BOND FUND
As a regulated investment company, the California Tax- Exempt Bond Fund
(the "Fund") will be relieved of liability for
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<PAGE> 71
California state franchise and corporate income tax to the extent its earnings
are distributed to its shareholders. The Fund will be taxed on its undistributed
taxable income. If for any year the Fund does not qualify for the special tax
treatment afforded regulated investment companies, all of the Fund's taxable
income (including interest income on California Municipal Securities for
franchise tax purposes only) may be subject to California state franchise or
income tax at regular corporate rates.
If, at the close of each quarter of its taxable year, at least 50% of
the value of the total assets of a regulated investment company, or series
thereof, consists of obligations the interest on which, if held by an
individual, is exempt from taxation by California ("California Exempt
Securities"), then a regulated investment company, or series thereof, will be
qualified to pay dividends exempt from California state personal income tax to
its non-corporate shareholders (hereinafter referred to as "California
exempt-interest dividends"). For this purpose, California Exempt Securities are
generally limited to California Municipal Securities and certain U.S. Government
and U.S. Possession obligations. "Series" of a regulated investment company is
defined as a segregated portfolio of assets, the beneficial interest in which is
owned by the holders of an exclusive class or series of stock of the company.
The Fund intends to qualify under the above requirements so that it can pay
California exempt-interest dividends. If the Fund fails to so qualify, no part
of its dividends to shareholders will be exempt from the California state
personal income tax. The Fund may reject purchase orders for shares if it
appears desirable to avoid failing to so qualify.
Within 60 days after the close of its taxable year, the Fund will
notify each shareholder of the portion of the dividends paid by the Fund to the
shareholder with respect to such taxable year which is exempt from California
state personal income tax. The total amount of California exempt-interest
dividends paid by the Fund with respect to any taxable year cannot exceed the
excess of the amount of interest received by the Fund for such year on
California Exempt Securities over any amounts that, if the Fund were treated as
an individual, would be considered expenses related to tax-exempt income or
amortizable bond premium and would thus not be deductible under federal income
or California state personal income tax law. The percentage of total dividends
paid by the Fund with respect to any taxable year which qualifies as California
exempt-interest dividends will be the same for all shareholders receiving
dividends from the Fund with respect to such year.
In cases where shareholders are "substantial users" or "related
persons" with respect to California Exempt Securities held by the Fund, such
shareholders should consult their tax advisers to determine whether California
exempt-interest
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<PAGE> 72
dividends paid by the Fund with respect to such obligations retain California
state personal income tax exclusion. In this connection rules similar to those
regarding the possible unavailability of federal exempt-interest dividend
treatment to "substantial users" are applicable for California state tax
purposes. See "Additional Information Concerning Taxes - Federal - California
Tax-Exempt Bond Fund" above.
To the extent, if any, dividends paid to shareholders are derived from
the excess of net long-term capital gains over net short-term capital losses,
such dividends will not constitute California exempt-interest dividends and will
generally be taxed as long-term capital gains under rules similar to those
regarding the treatment of capital gains dividends for federal income tax
purposes. See "Additional Information Concerning Taxes - Federal- All Funds"
above. Moreover, interest on indebtedness incurred by a shareholder to purchase
or carry Fund shares is not deductible for California state personal income tax
purposes if the Fund distributes California exempt-interest dividends during the
shareholder's taxable year.
The foregoing is only a summary of some of the important California
state personal income tax considerations generally affecting the Fund and its
shareholders. No attempt is made to present a detailed explanation of the
California state personal income tax treatment of the Fund or its shareholders,
and this discussion is not intended as a substitute for careful planning.
Further, it should be noted that the portion of any Fund dividends constituting
California exempt-interest dividends is excludable from income for California
state personal income tax purposes only. Any dividends paid to shareholders
subject to California state franchise tax or California state corporate income
tax may therefore be taxed as ordinary dividends to such purchasers
notwithstanding that all or a portion of such dividends is exempt from
California state personal income tax. Accordingly, potential investors in the
Fund, including, in particular, corporate investors which may be subject to
either California franchise tax or California corporate income tax, should
consult their tax advisers with respect to the application of such taxes to the
receipt of Fund dividends and as to their own California state tax situation, in
general.
OTHER INFORMATION
Depending upon the extent of 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, the
Funds may be subject to the tax laws of such states or localities.
Except as noted above with respect to California state personal income
taxation of dividends paid by the California Tax-
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<PAGE> 73
Exempt Bond Fund, income distributions may be taxable to shareholders under
state or local law as dividend income even though all or a portion of such
distributions may be derived from interest on tax-exempt obligations or U.S.
government obligations which, if realized directly, would be exempt from such
income taxes. Shareholders are advised to consult their tax advisers concerning
the application of state and local taxes.
The foregoing discussion is based on tax laws and regulations which are
in effect on the date of this Statement of Additional Information. Such laws and
regulations may be changed by legislative or administrative action. This
discussion is only a summary of some of the important tax considerations
generally affecting purchasers of Fund shares. No attempt is made to present a
detailed explanation of the federal income tax treatment of the Funds or their
shareholders, and this discussion is not intended as a substitute for careful
tax planning. Accordingly, potential purchasers of Fund shares should consult
their tax advisers with specific reference to their own tax situation.
MANAGEMENT
DIRECTORS AND OFFICERS OF THE COMPANY
The directors and officers of the Company, their addresses, ages and
principal occupations during the past five years are:
<TABLE>
<CAPTION>
Position with
Name and Address Age Company Principal Occupations
- ---------------- --- ------------- ---------------------
<S> <C> <C> <C>
Thomas M. Collins 61 Director Of counsel, law firm of
McDermott & Trayner McDermott & Trayner;
225 S. Lake Avenue Partner of the law firm
Suite 410 of Musick, Peeler &
Pasadena, CA 91101-3005 Garrett (until April,
1993); Trustee, Master
Investment Trust Series
I and Master Investment
Trust, Series II (registered
investment companies) (since
1993); former Director,
Bunker Hill Income
Securities, Inc. (registered
investment company) through
1991.
</TABLE>
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<PAGE> 74
<TABLE>
<CAPTION>
Position with
Name and Address Age Company Principal Occupations
- ---------------- --- ------------- ---------------------
<S> <C> <C> <C>
Douglas B. Fletcher 70 Vice Chairman Chairman of the Board
Fletcher Capital of the Board and Chief Executive
Advisors Incorporated Officer, Fletcher
4 Upper Newport Plaza Capital Advisors,
Suite 100 Incorporated, (registered
Newport Beach, CA 92660-2629 investment adviser)
1991 to date;
Partner, 1991
Newport Partners
(private venture
capital firm), 1981
to date; Chairman of
the Board and Chief
Executive Officer,
First Pacific
Advisors, Inc.
(registered
investment adviser)
and seven investment
companies under its
management, prior to
1983; former Allied
Member, New York
Stock Exchange;
Chairman of the
Board of FPA
Paramount Fund, Inc.
through 1984;
Director, TIS
Mortgage Investment
Company (real estate
investment trust);
Trustee and former
Vice Chairman of the
Board, Claremont
McKenna College;
Chartered Financial
Analyst.
Robert E. Greeley 62 Director Chairman, Page Mill
Page Mill Asset Asset Management (a
Management private investment
433 California Street company) since 1991;
Suite 900 Manager, Corporate
San Francisco, CA 94104 Investments, Hewlett
Packard Company from
1979 to 1991;
Trustee, Master
Investment Trust,
Series I and Master
Investment Trust,
Series II (since
1993); Director,
Morgan Grenfell
Small Cap Fund
(since 1986); former
Director, Bunker
Hill Income
Securities, Inc.
(since 1989)
(registered
investment
companies); former
Trustee, SunAmerica
Fund Group
(previously Equitec
</TABLE>
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<PAGE> 75
<TABLE>
<CAPTION>
Position with
Name and Address Age Company Principal Occupations
- ---------------- --- ------------- ---------------------
<S> <C> <C> <C>
Siebel Fund Group)
from 1984 to 1992.
Kermit O. Hanson 79 Director Vice Chairman of the
17760 14th Ave., N.W. Advisory Board, 1988 to
Seattle, WA 98177 date, Executive
Director, 1977 to
1988, Pacific Rim
Bankers Program (a
non-profit
educational
institution); Dean
Emeritus, 1981 to
date, Dean, 1964-81,
Graduate School of
Business
Administration,
University of
Washington;
Director, Washington
Federal Savings &
Loan Association;
Trustee, Seafirst
Retirement Funds
(since 1993)
(registered
investment company).
Cornelius J. Pings* 66 Chairman of President, Association
Association of American the Board and of American
Universities President Universities, February
One DuPont Circle 1993 to date; Provost,
Suite 730 1982 to January
Washington, DC 20036 1993, Senior Vice
President for
Academic Affairs,
1981 to January
1993, University of
Southern California;
Trustee, Master
Investment Trust,
Series I and Master
Investment Trust,
Series II (since
1995).
Kenneth L. Trefftzs 83 Director Private Investor;
11131 Briarcliff Drive formerly Distinguished
San Diego, CA 92131-1329 Emeritus Professor
of Finance and
Chairman of the
Department of
Finance and Business
Economics of the
Graduate School of
Business of the
University of
Southern California;
former Director,
Metro Goldwyn Mayer,
Inc.; Director,
Fremont General
Corporation
(insurance and
financial services
</TABLE>
-68-
<PAGE> 76
<TABLE>
<CAPTION>
Position with
Name and Address Age Company Principal Occupations
- ---------------- --- ------------- ---------------------
<S> <C> <C> <C>
holding company);
Director, Source
Capital, Inc.
(closed-end
investment company);
Director of three
open-end investment
companies managed by
First Pacific
Advisors, Inc.;
formerly Chairman of
the Board of
Directors (or
Trustees) of
nineteen investment
companies managed by
American Capital
Asset Management,
Inc.
Richard E. Stierwalt Executive Chairman of the Board
125 W. 55th Street 40 Vice President and Chief Executive
New York, NY 10019 Officer, July 1993 to
date, prior thereto
Senior Director,
Managing Director
and Chief Executive
Officer of the
Administrator and
Distributor,
February 1987 to
July 1993;
President, Master
Investment Trust,
Series I, Master
Investment Trust,
Series II and
Seafirst Retirement
Funds (since 1993);
First Vice
President, Trust
Operation
Administration,
Security Pacific
National Bank,
1983-1987.
William B. Blundin 57 Executive Vice Vice Chairman, July 1993
125 W. 55th Street President to date, prior thereto
New York, NY 10019 Director and President
of the Administrator and
Distributor, February
1987 to July 1993;
Executive Vice
President, Master
Investment Trust, Series
II and Seafirst
Retirement Funds (since
1993); Senior Vice
President, Shearson
Lehman Brothers, 1978-
1987.
Irimga McKay 35 Vice Senior Vice President,
7863 Girard Avenue President July 1993 to date, prior
Suite 306 thereto First Vice
La Jolla, CA 92037 President of the
</TABLE>
-69-
<PAGE> 77
<TABLE>
<CAPTION>
Position with
Name and Address Age Company Principal Occupations
- ---------------- --- ------------- ---------------------
<S> <C> <C> <C>
Administrator and
Distributor, November
1988 to July 1993; Vice
President, Master
Investment Trust, Series
II and Seafirst
Retirement Funds (since
1993); Regional Vice
President, Continental
Equities, June 1987 to
November 1988; Assistant
Wholesaler, VMS Realty
Partners (a real estate
limited partnership), May
1986 to June 1987.
W. Eugene Spurbeck 39 Assistant Vice Manager of Client
BISYS Fund Services President Services of the
515 Figueroa Street Administrator (1993 to
Suite 335 date); Assistant Vice
Los Angeles, CA 92307 President, Master
Investment Trust, Series
II; Vice President,
Seafirst Retirement Funds
(since 1995); Vice
President of Retail
Lending Operations Banc
One (1989 to 1993).
Martin R. Dean 31 Treasurer Manager of Fund
3435 Stelzer Road Accounting of BISYS
Columbus, OH 43219 Fund Services, May 1994
to Present; Treasurer,
Master Investment Trust,
Series II and Seafirst
Retirement Funds (since
1995); Senior Manager at
KPMG Peat Marwick
previously 1990-1994.
W. Bruce McConnel, III 52 Secretary Partner of the law firm
1345 Chestnut Street of Drinker Biddle &
Philadelphia National Bank Reath. Secretary,
Building, Suite 1100 Master Investment Trust,
Philadelphia, PA 19107 Series I, Master
Investment Trust, Series
II and Seafirst
Retirement Funds
</TABLE>
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<PAGE> 78
<TABLE>
<CAPTION>
Position with
Name and Address Age Company Principal Occupations
- ---------------- --- ------------- ---------------------
<S> <C> <C> <C>
George O. Martinez 35 Assistant Senior Vice President
3435 Stelzer Road Secretary and Director of Legal
Columbus, OH 43219 and Compliance Services,
of the Administrator.
since April 1995;
Assistant Secretary,
Master Investment Trust,
Series II and Seafirst
Retirement Funds (since
1995); prior thereto,
Vice President and
Associate General
Counsel, Alliance Capital
Management, L.P.
</TABLE>
- --------------
* Mr. Pings is an "interested director" of the Company as defined in the 1940
Act.
The Audit Committee of the Board is comprised of all directors and is
chaired by Dr. Trefftzs. The Board does not
have an Executive Committee.
Each director is entitled to receive an annual fee of $25,000 plus
$1,000 for each day that a director participates in all or a part of a Board
meeting; the President receives an additional $20,000 per annum for his services
as President; Mr. Collins, in consideration of his years of service as President
and Chairman of the Board, receives an additional $40,000 per annum in severance
until February 28, 1997; each member of a Committee of the Board is entitled to
receive $1,000 for each Committee meeting they participate in (whether or not
held on the same day as a Board meeting); and each Chairman of a Committee of
the Board shall be entitled to receive an annual retainer of $1,000 for his
services as Chairman of the Committee. The Funds, and each other fund of the
Company, pays its proportionate share of these amounts based on relative net
asset values.
For the fiscal year ended February 28, 1995, the Company paid or
accrued for the account of its directors as a group for services in all
capacities a total of $334,168. Of that amount, $22,531, $23,089, $22,341 and
$22,020 of directors' compensation were allocated to the Aggressive Growth,
California Tax-Exempt Bond, U.S. Government Securities and Capital Income Funds,
respectively. Each director is also reimbursed for out-of-pocket expenses
incurred as a director. Drinker Biddle & Reath, of which Mr. McConnel is a
partner, receives legal fees as counsel to the Company. As of the date of this
Statement of Additional Information, the directors and officers of the
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<PAGE> 79
Company, as a group, own less than 1% of the outstanding shares of each of the
Company's investment portfolios.
Under a retirement plan approved by the Board of Directors, including a
majority of its directors who are not "interested persons" of the Company,
effective March 1, 1995, a director who dies or resigns after five years of
service is entitled to receive ten annual payments each equal to the greater of:
(i) 50% of the annual director's retainer that was payable by the Company during
the year of his/her death or resignation, or (ii) 50% of the annual director's
retainer then in effect for directors of the Company during the year of such
payment. A director who dies or resigns after nine years of service is entitled
to receive ten annual payments each equal to the greater of: (i) 100% of the
annual director's retainer that was payable by the Company during the year of
his/her death or resignation, or (ii) 100% of the annual director's retainer
then in effect for directors of the Company during the year of such payment.
Further, the amount payable each year to a director who dies or resigns is
increased by $1,000 for each year of service that the director provided as
Chairman of the Board.
Years of service for purposes of calculating the benefit described
above are based upon service as a director or Chairman after February 28, 1994.
Retirement benefits in which a director has become vested may not be reduced by
later Board action.
In lieu of receiving ten annual payments, a director may elect to
receive substantially equivalent benefits through a single-sum cash payment of
the present value of such benefits paid by the Company within 45 days of the
death or resignation of the director. The present value of such benefits is to
be calculated (i) based on the retainer that was payable by the Company during
the year of the director's death or resignation (and not on any retainer payable
to directors thereafter), and (ii) using the interest rate in effect as of the
date of the director's death or resignation by the Pension Benefit Guaranty
Corporation (or any successor thereto) for valuing immediate annuities under
terminating defined benefit pension plans. A director's election to receive a
single sum must be made in writing within the 30 calendar days after the date
the individual is first elected as a director.
In addition to the foregoing, the Board of Directors may, in its
discretion and in recognition of a director's period of service before March 1,
1994 as a director and possibly as Chairman, authorize the Company to pay a
retirement benefit following the director's death or resignation (unless the
director has vested benefits as a result of completing nine years of service).
Any such action shall be approved by the Board and by a majority of the
directors who are not "interested persons"
-72-
<PAGE> 80
of the Company within 120 days following the director's death or resignation and
may be authorized as a single sum cash payment or as not more than ten annual
payments (beginning the first anniversary of the director's date of death or
resignation and continuing for one or more anniversary date(s) thereafter).
The obligation of the Company to pay benefits to a former director is
neither secured nor funded by the Company but shall be binding upon its
successors in interest. The payment of benefits under the retirement plan has no
priority or preference over the lawful claims of the Company's creditors or
shareholders, and the right to receive such payments is not assignable or
transferable by a director (or former director) other than by will, by the laws
of descent and distribution, or by the director's written designation of a
beneficiary.
The following chart provides certain information about the director
fees from the Company as of February 28, 1995:
<TABLE>
<CAPTION>
==============================================================================================================================
TOTAL
COMPENSATION
PENSION OR FROM
RETIREMENT ESTIMATED REGISTRANT
AGGREGATE BENEFITS ANNUAL AND FUND
COMPENSATION ACCRUED AS BENEFITS COMPLEX(*)
NAME OF PERSON/ FROM THE PART OF FUND UPON PAID TO
POSITION COMPANY EXPENSES RETIREMENT DIRECTORS
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Thomas M. Collins $100,000 $0 $0 $110,000
President and
Chairman of the
Board(+)
- ----------------------------------------------------------------------------------------------------------------------------
Douglas B. Fletcher $57,500 $0 $0 $57,500
Vice Chairman of
the Board
- ----------------------------------------------------------------------------------------------------------------------------
Robert E. Greeley(**) $57,500 $0 $0 $65,781
Director
- ----------------------------------------------------------------------------------------------------------------------------
Kermit O. Hanson $57,500 $0 $0 $63,500
Director
- ----------------------------------------------------------------------------------------------------------------------------
Cornelius J. Pings $57,500 $0 $0 $57,500
Director
- ----------------------------------------------------------------------------------------------------------------------------
Kenneth L. Trefftzs $57,500 $0 $0 $57,500
Director
============================================================================================================================
</TABLE>
- --------------
* The "Fund Complex" consists of the Company, Seafirst Retirement Funds, the
Master Investment Trust, Series I and Master Investment Trust, Series II.
** Mr. Greeley became a director of the Company on April 25, 1994.
+ Mr. Collins was President and Chairman of the Board of the Company until
August 31, 1995.
-73-
<PAGE> 81
INVESTMENT ADVISER
Bank of America is the successor by merger to Security Pacific National
Bank ("Security Pacific"), which previously served as investment adviser to the
Company since the commencement of its operations. In the investment advisory
agreements, Bank of America has agreed to provide investment advisory services
as described in each Prospectus. Bank of America has also agreed to pay all
expenses incurred by it in connection with its activities under its agreements
other than the cost of securities, including brokerage commissions, if any,
purchased for the Funds. In rendering its advisory services, Bank of America may
utilize Bank officers from one or more of the departments of the Bank which are
authorized to exercise the fiduciary powers of Bank of America with respect to
the investment of trust assets. In some cases, these officers may also serve as
officers, and utilize the facilities, of wholly-owned subsidiaries and other
affiliates of Bank of America or its parent corporation. In addition, the
Investment Advisory Agreement with respect to the Capital Income Fund provides
that Bank of America may, in its discretion, provide advisory services through
its own employees or employees of one or more of its affiliates that are under
the common control of Bank of America's parent, BankAmerica Corporation;
provided such employees are under the management of Bank of America.
For the services provided and expenses assumed pursuant to the
investment advisory agreement, the Company has agreed to pay Bank of America
fees, accrued daily and payable monthly, at the annual rates of .45% of the net
assets of the Capital Income Fund; .60% of the net assets of the Aggressive
Growth Fund; .35% of the net assets of the U.S. Government Securities Fund; and
.40% of the net assets of the California Tax-Exempt Bond Fund. The fees payable
to Bank of America are not subject to reduction as the value of each Fund's net
assets increases. From time to time, Bank of America may waive fees or reimburse
the Company for expenses voluntarily or as required by certain state securities
laws.
For the fiscal years ended February 28, 1995, 1994 and 1993, advisory
fees (net of waivers) paid or payable to Bank of America were as follows:
Aggressive Growth Fund - $816,300, $1,016,640, and $903,058, respectively;
California Tax-Exempt Bond Fund - $606,131, $721,895 and $157,000, respectively;
Capital Income Fund - $572,638, $39,298 and $0, respectively; and U.S.
Government Securities Fund - $397,905, $507,308 and $45,386, respectively. For
the three fiscal years indicated, Bank of America did not waive any fees with
resect to the Aggressive Growth Fund; waived fees with respect to the California
Tax- Exempt Bond Fund in the amounts of $242,173, $190,993 and $500,267,
respectively; waived fees with respect to the Capital Income Fund in the amounts
of $359,205, $387,148 and $41,517
-74-
<PAGE> 82
respectively; and waived fees with respect to the U.S. Government Securities
Fund in the amounts of $0, $20,985 and $347,564, respectively. Additionally, for
the fiscal years ended February 28, 1995, 1994 and 1993, Bank of America assumed
certain operating expenses (excluding certain shareholder servicing and
distribution expenses described below) of the Capital Income Fund in the amount
of $0, $0 and $191,339, respectively.
See "Management - Administrator" for instances where the Funds'
investment adviser is required to make expense reimbursements to the Company.
The investment advisory agreements for the Funds provide that Bank of
America shall not be liable for any error of judgment or mistake of law or for
any loss suffered in connection with the performance of the investment advisory
agreements, except a loss resulting from a breach of fiduciary duty with respect
to the receipt of compensation for services or a loss resulting from willful
misfeasance, bad faith or negligence in the performance of its duties or from
reckless disregard by it of its duties and obligations thereunder.
THE GLASS-STEAGALL ACT AND PROPOSED LEGISLATION
The Glass-Steagall Act, among other things, prohibits banks from
engaging in the business of underwriting securities, although national and
state-chartered banks generally are permitted to purchase and sell securities
upon the order and for the account of their customers. In 1971, the United
States Supreme Court held in Investment Company Institute v. Camp that the
Glass-Steagall Act prohibits a national bank from operating a fund for the
collective investment of managing agency accounts. Subsequently, the Board of
Governors of the Federal Reserve System (the "Board") issued a regulation and
interpretation to the effect that the Glass-Steagall Act and such decision
forbid a bank holding company registered under the Federal Bank Holding Company
Act of 1956 (the "Holding Company Act") or any non-bank affiliate thereof from
sponsoring, organizing or controlling a registered, open-end investment company
continuously engaged in the issuance of its shares, but do not prohibit such a
holding company or affiliate from acting as investment adviser, transfer agent
and custodian to such an investment company. In 1981, the United States Supreme
Court held in Board of Governors of the Federal Reserve System v. Investment
Company Institute that the Board did not exceed its authority under the Holding
Company Act when it adopted its regulation and interpretation authorizing bank
holding companies and their non-bank affiliates to act as investment advisers to
registered closed-end investment companies.
Bank of America believes that if the question was properly presented, a
court should hold that Bank of America may
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<PAGE> 83
perform the services for the Company contemplated by the investment advisory
agreement, the Prospectuses, and this Statement of Additional Information
without violation of the Glass-Steagall Act or other applicable banking laws or
regulations. It should be noted, however, that there have been no cases deciding
whether a national bank may perform services comparable to those performed by
Bank of America and that future changes in either federal or state statutes and
regulations relating to permissible activities of banks or trust companies and
their subsidiaries or affiliates, as well as further judicial or administrative
decisions or interpretations of present and future statutes and regulations,
could prevent Bank of America from continuing to perform such services for the
Company or from continuing to purchase Fund shares for the accounts of its
customers. (For a discussion of the Glass Steagall Act in connection with the
Company's Shareholder Service Plan, see "Plan Payments" in the Funds'
Prospectuses.)
On the other hand, as described herein, the Funds are currently
distributed by Concord Financial Group, Inc., and Concord Holding Corporation,
its parent, provides the Funds with administrative services. If current
restrictions under the Glass-Steagall Act preventing a bank from sponsoring,
organizing, controlling, or distributing shares of an investment company were
relaxed, the Company expects that Bank of America would consider the possibility
of offering to perform some or all of the services now provided by Concord
Holding Corporation or Concord Financial Group, Inc. From time to time,
legislation modifying such restriction has been introduced in Congress which, if
enacted, would permit a bank holding company to establish a non-bank subsidiary
having the authority to organize, sponsor and distribute shares of an investment
company. If this or similar legislation were enacted, the Company expects that
Bank of America's parent bank holding company would consider the possibility of
one of its non-bank subsidiaries offering to perform some or all of the services
now provided by Concord Holding Corporation or Concord Financial Group, Inc. It
is not possible, of course, to predict whether or in what form such legislation
might be enacted or the terms upon which Bank of America or such a non-bank
affiliate might offer to provide services for consideration by the Company's
Board of Directors.
ADMINISTRATOR
Concord Holding Corporation (the "Administrator"), with offices at 125
W. 55th Street, 11th Floor, New York, New York 10019 and 3435 Stelzer Road,
Columbus, Ohio 43219, is a wholly-owned subsidiary of The BISYS Group, Inc. The
Administrator also serves as administrator to several other investment
companies.
The Administrator provides administrative services to the Company as
described in the Funds' Prospectuses. Each
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<PAGE> 84
administration agreement will continue in effect until October 31, 1996 and
thereafter will be extended with respect to each Fund for successive periods of
one year, provided that each such extension is specifically approved (a) by vote
of a majority of those members of the Company's Board of Directors who are not
interested persons of any party to the agreement, cast in person at a meeting
called for the purpose of voting on such approval, and (b) the Company's Board
of Directors or by vote of a majority of the outstanding voting securities of
such Fund. The agreement is terminable at any time without penalty by the
Company's Board of Directors or by a vote of a majority of a Fund's outstanding
shares upon 60 days' notice to the Administrator, or by the Administrator upon
90 days' notice to the Company.
The Company has agreed to pay the Administrator a fee for its services
as Administrator, accrued daily and payable monthly, at the annual rates of .20%
percent of the average daily net assets of the U.S. Government Securities and
Capital Income Funds and .30% of the average daily net assets of the Aggressive
Growth and California Tax-Exempt Bond Funds. The fees payable to the
Administrator are not subject to reduction as the value of each Fund's net
assets increases. From time to time, the Administrator may waive fees or
reimburse the Company for expenses, either voluntarily or as required by certain
state securities laws.
For the fiscal years ended February 28, 1995, 1994 and 1993,
administration fees paid or payable to the Administrator (net of waivers) were
as follows: Aggressive Growth Fund - $408,150, $508,320 and $451,529,
respectively; California Tax- Exempt Bond Fund - $454,249, $541,341 and
$130,555, respectively; Capital Income Fund - $414,134, $17,466 and $0,
respectively; and U.S. Government Securities Fund - $227,374, $301,881 and
$116,483, respectively. For the fiscal years indicated, the Administrator did
not waive any administration fees with respect to the Aggressive Growth Fund;
waived $181,979, $143,325 and $362,395, respectively, in administration fees
with respect to the California Tax-Exempt Bond Fund; waived $0, $172,065 and
$18,452, respectively, in administration fees with respect to the Capital Income
Fund; and waived $0, $0 and $108,060, respectively, in administration fees with
respect to the U.S. Government Securities Fund. In addition, the Administrator
reimbursed operating expenses of the Capital Income Fund in the amount of $0 and
$33,887, respectively for the years ended February 28, 1995 and 1994.
If total expenses borne by any Fund in any fiscal year exceed the
expense limitations imposed by applicable state securities regulations, the
Company may deduct from the payments to be made with respect to such Fund to
Bank of America and the Administrator, respectively, or Bank of America and the
Administrator each will bear, the amount of such excess to the
-77-
<PAGE> 85
extent required by such regulations in proportion to the fees otherwise payable
to them for such year. Such amount, if any, will be estimated, reconciled and
effected or paid, as the case may be, on a monthly basis. As of the date of this
Statement of Additional Information, the most restrictive expense limitation
that may be applicable to the Company limits aggregate annual expenses with
respect to a Fund, including management and advisory fees but excluding
interest, taxes, brokerage commissions, and certain other expenses, to 2-1/2% of
the first $30 million of its average daily net assets, 2% of the next $70
million, and 1-1/2% of its remaining average daily net assets. During the course
of the Company's fiscal year, the Administrator and Bank of America may assume
certain expenses and/or not receive payment of fees of one or more of the
Company's Funds, while retaining the ability to be reimbursed by such Funds for
such amounts prior to the end of the fiscal year. This will have the effect of
increasing yield to investors at the time such fees are not received or amounts
are assumed and decreasing yield when such fees or amounts are reimbursed.
The Administrator will bear all expenses in connection with the
performance of its services under the administration agreement with the
exception of the fees charged by The Bank of New York for certain fund
accounting services which are borne by the Funds. See "General
Information--Custodian and Transfer Agent" below. Expenses borne by the Funds
include taxes, interest, brokerage fees and commissions, if any, fees of Board
members who are not officers, directors, partners, employees or holders of 5% or
more of the outstanding voting securities of Bank of America or the
Administrator or any of their affiliates, Securities and Exchange Commission
fees and state securities qualification fees, advisory fees, administration
fees, charges of custodians, transfer and dividend disbursing agents' fees,
certain insurance premiums, outside auditing and legal expenses, costs of
maintaining corporate existence, costs attributable to investor services,
including without limitation telephone and personnel expenses, costs of
preparing and printing prospectuses and Statements of Additional Information for
regulatory purposes, cost of shareholders' reports and corporate meetings and
any extraordinary expenses. Certain shareholder servicing and/or distribution
fees in connection with the Company's shares are also paid by the Company. See
"Distributor and Plan Payments."
The administration agreements provide that the Administrator shall not
be liable for any error of judgment or mistake of law or any loss suffered by
the Company or the Portfolios in connection with the performance of the
administration agreements, except a loss resulting from willful misfeasance, bad
faith or negligence in the performance of its duties or from the reckless
disregard by it of its obligations and duties thereunder.
-78-
<PAGE> 86
DISTRIBUTOR AND PLAN PAYMENTS
Concord Financial Group, Inc. (the "Distributor"), a wholly-owned
subsidiary of the Administrator, acts as distributor of the shares of the
Company. Shares are sold on a continuous basis by the Distributor. The
Distributor has agreed to use its best efforts to solicit orders for the sale of
the Company's shares although it is not obliged to sell any particular amount of
shares. The distribution agreement shall continue in effect with respect to each
Fund until October 31, 1996. Thereafter, if not terminated, the distribution
agreement shall continue automatically for successive terms of one year,
provided that such continuance is specifically approved at least annually (a) by
a vote of a majority of those members of the Board of Directors of the Company
who are not parties to the distribution agreement or "interested persons" of any
such party, cast in person at a meeting called for the purpose of voting on such
approval, and (b) by the Board of Directors of the Company or by vote of a
"majority of the outstanding voting securities" of the Funds as to which the
distribution agreement is effective; provided, however, that the distribution
agreement may be terminated by the Company at any time, without the payment of
any penalty, by vote of a majority of the entire Board of Directors of the
Company or by a vote of a "majority of the outstanding voting securities" of
such Funds on 60 days' written notice to the Distributor, or by the Distributor
at any time, without the payment of any penalty, on 90 days' written notice to
the Company. The agreement will automatically and immediately terminate in the
event of its "assignment".
For the fiscal year ended February 28, 1995, the Distributor received
sales loads in connection with share purchases as follows: Aggressive Growth
Fund -- $340,853; California Tax-Exempt Bond Fund -- $322,982; U.S. Government
Securities Fund -- $181,635; and Capital Income Fund -- $2,449,559. Of these
amounts, the Distributor and various affiliates of Bank of America retained
$60,878 and $257,259, respectively, with respect to the Aggressive Growth Fund;
$37,001 and $268,563, respectively, with respect to the California Tax- Exempt
Bond Fund; $21,022 and $90,642, respectively, with respect to the U.S.
Government Securities Fund; and $201,638 and $388,254, respectively, with
respect to the Capital Income Fund. The balance was paid to selling dealers. The
following table shows all sales loads, commissions and other compensation
received by the Distributor directly or indirectly from each of these Funds
during the fiscal year stated above:
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<PAGE> 87
<TABLE>
<CAPTION>
Brokerage
Commis-
Net Under- sions in
writing Dis- Compensation connection Other
counts and on Redemption with Fund Compen-
Commissions and Repurchase Transactions sation(1)
----------- -------------- ------------ ---------
<S> <C> <C> <C> <C>
Concord Financial
Group, Inc.
Aggressive $60,878 $0 $0 $615,902
Growth Fund
California $37,001 $0 $0 $652,834
Tax-Exempt Bond Fund
U.S. Government $21,022 $0 $0 $234,560
Securities Fund
Capital Income $201,638 $0 $0 $456,942
Fund
</TABLE>
- --------------
(1) Represents the total of (i) amounts paid to the Administrator for
administrative services provided to the Fund (see "Management of the
Company-Administrator" above) and (ii) payments made under the Shareholder
Service Plan (see discussion in next section).
In addition to the sales loads described above, the Distributor is
entitled to payment by the Company for certain shareholder servicing expenses
under the Shareholder Service Plan (the "Plan") adopted by the Company. The
Funds have in the past had a Distribution Plan pursuant to which payments were
made for distribution and related expenses; however, effective July 1, 1993 the
Board of Directors eliminated the Distribution Plan.
Under the Shareholder Service Plan, the Company pays the Distributor,
with respect to the Funds for (a) nondistribution shareholder services provided
by the Distributor to Service Organizations and/or the beneficial owners of Fund
shares, including, but not limited to shareholder servicing provided by the
Distributor at facilities dedicated for Company use, provided such shareholder
servicing is not duplicative of the servicing otherwise provided on behalf of
the Funds, and (b) fees paid to Service Organizations (which may include the
Distributor itself) for the provision of support services for shareholders for
whom the Service Organization is the dealer of record or holder of record or
with whom the Service Organization has a servicing relationship ("Clients").
Support services provided by Service Organizations may include, among
other things: (i) establishing and maintaining accounts and records relating to
Clients that invest in Fund shares; (ii) processing dividend and distribution
payments from the Funds on behalf of Clients; (iii) providing information
-80-
<PAGE> 88
periodically to Clients regarding their positions in shares; (iv) arranging for
bank wires; (v) responding to Client inquiries concerning their investments in
Fund shares; (vi) providing the information to the Funds necessary for
accounting or subaccounting; (vii) if required by law, forwarding shareholder
communications from the Funds (such as proxies, shareholder reports, annual and
semi-annual financial statements and dividend, distribution and tax notices) to
Clients; (viii) assisting in processing exchange and redemption requests from
Clients; (ix) assisting Clients in changing dividend options, account
designations and addresses; and (x) providing such other similar services.
The Shareholder Service Plan provides that the Distributor is entitled
to receive payments for expenses on a monthly basis, at an annual rate not
exceeding .25% of the average daily net assets during such month of the
Aggressive Growth, California Tax-Exempt Bond, U.S. Government Securities and
Capital Income Funds for shareholder servicing expenses. The calculation of a
Fund's average daily net assets for these purposes does not include assets held
in accounts opened via a transfer of assets from trust and agency accounts of
Bank of America. Further, payments made out of or charged against the assets of
a particular Fund must be in payment for expenses incurred on behalf of the
Fund.
If in any month the Distributor expends or is due more monies than can
be immediately paid due to the percentage limitations described above, the
unpaid amount is carried forward from month to month while the Plan is in effect
until such time, if ever, when it can be paid in accordance with such percentage
limitations. Conversely, if in any month the Distributor does not expend the
entire amount then available under the Plan, and assuming that no unpaid amounts
have been carried forward and remain unpaid, then the amount not expended will
be a credit to be drawn upon by the Distributor to permit future payment.
However, any unpaid amounts or credits due under the Plans may not be "carried
forward" beyond the end of the fiscal year in which such amounts or credits due
are accrued.
For the fiscal year ended February 28, 1995, pursuant to the
Shareholder Service Plan, the Aggressive Growth Fund was charged $340,125, of
which amount $207,152, $0 and $61,145 was paid to the Distributor, Bank of
America and affiliates of Bank of America, respectively; the Capital Income Fund
was charged $517,667, of which amount $42,508, $0 and $333,632 was paid to the
Distributor, Bank of America and affiliates of Bank of America, respectively;
the U.S. Government Securities Fund was charged $284,218, of which amount
$7,186, $0 and $194,847 was paid to the Distributor, Bank of America and
affiliates of Bank of America, respectively; and the California Tax-Exempt Bond
Fund was charged $530,190 of which amount $198,585, $0 and $253,362
-81-
<PAGE> 89
was paid to the Distributor, Bank of America and affiliates of
Bank of America, respectively.
The Company's Board of Directors has concluded that the Plan will
benefit the Funds and their shareholders. The Shareholder Service Plan is
subject to annual reapproval by a majority of the Non-Interested Plan Directors
and is terminable at any time with respect to any Fund by a vote of a majority
of such Directors or by vote of the holders of a majority of the shares of the
Fund involved. Any agreement entered into pursuant to the Plans with a Service
Organization is terminable with respect to any Fund without penalty, at any
time, by vote of a majority of the Non-Interested Plan Directors, by vote of the
holders of a majority of the shares of such Fund, by the Distributor or by the
Service Organization. Each agreement will also terminate automatically in the
event of its assignment.
The Company understands that Bank of America and/or some Service
Organizations may charge their clients a direct fee for administrative and
shareholder services in connection with the holding of Fund shares. These fees
would be in addition to any amounts which might be received under the Plans.
Small, inactive long-term accounts involving such additional charges may not be
in the best interest of shareholders.
YIELD AND TOTAL RETURN
From time to time, the yields and the total returns of the Funds may be
quoted in and compared to other mutual funds with similar investment objectives
in advertisements, shareholder reports or other communications to shareholders.
The Funds may also include calculations in such communications that describe
hypothetical investment results. (Such performance examples will be based on an
express set of assumptions and are not indicative of the performance of any
Fund.) Such calculations may from time to time include discussions or
illustrations of the effects of compounding in advertisements. "Compounding"
refers to the fact that, if dividends or other distributions on a Fund
investment are reinvested by being paid in additional Fund shares, any future
income or capital appreciation of a Fund would increase the value, not only of
the original Fund investment, but also of the additional Fund shares received
through reinvestment. As a result, the value of the Fund investment would
increase more quickly than if dividends or other distributions had been paid in
cash. The Funds may also include discussions or illustrations of the potential
investment goals of a prospective investor (including but not limited to tax
and/or retirement planning), investment management techniques, policies or
investment suitability of a Fund, economic conditions, legislative developments
(including pending legislation), the effects of inflation and historical
performance of various asset classes, including but not limited to stocks, bonds
and Treasury bills.
-82-
<PAGE> 90
From time to time advertisements or communications to shareholders may summarize
the substance of information contained in shareholder reports (including the
investment composition of a Fund), as well as the views of the investment
adviser as to current market, economic, trade and interest rate trends,
legislative, regulatory and monetary developments, investment strategies and
related matters believed to be of relevance to a Fund. The Funds may also
include in advertisements charts, graphs or drawings which illustrate the
potential risks and rewards of investment in various investment vehicles,
including but not limited to stocks, bonds, Treasury bills and shares of a Fund.
In addition, advertisements or shareholder communications may include a
discussion of certain attributes or benefits to be derived by an investment in a
Fund. Such advertisements or communications may include symbols, headlines or
other material which highlight or summarize the information discussed in more
detail therein. With proper authorization, a Fund may reprint articles (or
excerpts) written regarding the Fund and provide them to prospective
shareholders. Performance information with respect to the Funds is generally
available by calling (800) 346-2087.
Yield Calculations. The yield of a Fund is calculated by dividing the
net investment income per share (as described below) earned by the Fund during a
30-day (or one month) period by the maximum offering price per share on the last
day of the period and annualizing the result on a semi-annual basis by adding
one to the quotient, raising the sum to the power of six, subtracting one from
the result and then doubling the difference. The Fund's net investment income
per share earned during the period is based on the average daily number of
shares outstanding during the period entitled to receive dividends and includes
dividends and interest earned during the period minus expenses accrued for the
period, net of reimbursements. This calculation can be expressed as follows:
a-b
Yield = 2 ((----- + 1)(6) - 1)
cd
Where: a = dividends and interest earned during the period.
b = expenses accrued for the period (net of reimbursements).
c = the average daily number of shares outstanding during the
period that were entitled to receive dividends.
d = maximum offering price per share on the last day of the
period.
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<PAGE> 91
For the purpose of determining net investment income earned during the
period (variable "a" in the formula), dividend income on equity securities is
recognized by accruing 1/360 of the stated dividend rate of the security each
day. Except as noted below, interest earned on debt obligations is calculated by
computing the yield to maturity of each obligation based on the market value of
the obligation (including actual accrued interest) at the close of business on
the last business day of each month, or, with respect to obligations purchased
during the month, the purchase price (plus actual accrued interest), and
dividing the result by 360 and multiplying the quotient by the market value of
the obligation (including actual accrued interest) in order to determine the
interest income on the obligation for each day of the subsequent month that the
obligation is held. For purposes of this calculation, it is assumed that each
month contains 30 days. The maturity of an obligation with a call provision is
the next call date on which the obligation reasonably may be expected to be
called or, if none, the maturity date. With respect to debt obligations
purchased at a discount or premium, the formula generally calls for amortization
of the discount or premium. The amortization schedule will be adjusted monthly
to reflect changes in the market values of such debt obligations.
Interest earned on tax-exempt obligations that are issued without
original issue discount and have a current market discount is calculated by
using the coupon rate of interest instead of the yield to maturity. In the case
of tax-exempt obligations that are issued with original issue discount but which
have discounts based on current market value that exceed the then-remaining
portion of the original issue discount (market discount), the yield to maturity
is the imputed rate based on the original issue discount calculation. On the
other hand, in the case of tax-exempt obligations that are issued with original
issue discount but which have the discounts based on current market value that
are less than the then-remaining portion of the original issue discount (market
premium), the yield to maturity is based on the market value.
With respect to mortgage or other receivables-backed obligations which
are expected to be subject to monthly payments of principal and interest ("pay
downs"), (a) gain or loss attributable to actual monthly pay downs are accounted
for as an increase or decrease to interest income during the period; and (b) a
Fund or Portfolio may elect either (i) to amortize the discount and premium on
the remaining security, based on the cost of the security, to the weighted
average maturity date, if such information is available, or to the remaining
term of the security, if any, if the weighted average maturity date is not
available, or (ii) not to amortize discount or premium on the remaining
security.
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<PAGE> 92
Undeclared earned income will be subtracted from the maximum offering
price per share (variable "d" in the formula). Undeclared earned income is the
net investment income which, at the end of the base period, has not been
declared as a dividend, but is reasonably expected to be and is declared and
paid as a dividend shortly thereafter. A Fund's maximum offering price per share
for purposes of the formula includes the maximum sales load imposed by the Fund
- -- currently 4.50% of the per share offering price.
Based on the foregoing calculations, the yields of the U.S. Government
Securities Fund and the Capital Income Fund (after fee waivers and expense
reimbursements by Bank of America and the Administrator) for the 30 day period
ended February 28, 1995 were 6.40% and 4.83%, respectively. Based on the
foregoing calculations the California Tax-Exempt Bond Fund's yield (after fee
waivers) for the 30 day period ended February 28, 1995 was 5.06% and its
"tax-equivalent" yield was 7.75%. The Fund's "tax- equivalent" yield is computed
by: (a) dividing the portion of the Fund's yield (calculated as above) that is
exempt from both federal and California state income taxes by one minus a stated
combined federal and California state income tax rate; (b) dividing the portion
of the Fund's yield (calculated as above) that is exempt from federal income tax
only by one minus a stated federal income tax rate; and (c) adding the figures
resulting from (a) and (b) above to that portion, if any, of the Fund's yield
that is not exempt from federal income tax. The combined federal and California
income tax rate used in calculating the Fund's "tax-equivalent" yield for the 30
day period ended February 28, 1995 was 34.70%.
Total Return Calculations. The Funds compute their average annual total
returns by determining the average annual compounded rates of return during
specified periods that equate the initial amount invested to the ending
redeemable value of such investment. This is done by dividing the ending
redeemable value of a hypothetical $1,000 initial payment by $1,000 and raising
the quotient to a power equal to one divided by the number of years (or
fractional portion thereof) covered by the computation and subtracting one from
the result. This calculation can be expressed as follows:
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<PAGE> 93
ERV (1/n)
T = [(-----) - 1]
P
Where: T = average annual total return.
ERV = ending redeemable value at the end of the period
covered by the computation of a hypothetical $1,000
payment made at the beginning of the period.
P = hypothetical initial payment of $1,000.
n = period covered by the computation, expressed in terms
of years.
The Funds compute their aggregate total returns by determining the
aggregate 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:
ERV
aggregate total return = [(----- - 1)]
P
The calculations of average annual total return and aggregate total
return assume the reinvestment of all dividends and capital gain distributions
on the reinvestment dates during the period. The ending redeemable value
(variable "ERV" in each formula) is determined by assuming complete redemption
of the hypothetical investment and the deduction of all nonrecurring charges at
the end of the period covered by the computations. In addition, the Funds'
average annual total return and aggregate total return quotations reflect the
deduction of the maximum sales load charged in connection with the purchase of
Fund shares.
Based on the foregoing calculations, the average annual total returns
for the Aggressive Growth Fund for the one-year, five-year and ten year periods
ended February 28, 1995 were (7.93)%, 12.41% and 14.01%, respectively. The
aggregate total returns for the Aggressive Growth Fund for the same three
periods were (7.93)%, 79.52% and 271.40%, respectively.
Based on the foregoing calculations, the average annual total returns
(after fee waivers and expense reimbursements) for the Capital Income Fund for
the one-year period ended February 28, 1995, for the five-year period ended
February 28, 1995 and for the period September 25, 1987 (commencement of
operations) to
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February 28, 1995 were (9.86)%, 12.99% and 12.22%, respectively. The aggregate
total returns for the Capital Income Fund for the same three periods were
(9.86)%, 84.21% and 136%, respectively.
Based on the foregoing calculations, the average annual total returns
(after fee waivers and expense reimbursements) for the U.S. Government
Securities Fund for the one-year period ended February 28, 1995, for the
five-year period ended February 28, 1995 and for the period January 7, 1988
(commencement of operations) to February 28, 1995 were (4.21)%, 6.85% and 7.68%,
respectively. The aggregate total returns for the U.S. Government Securities
Fund for the same three periods were (4.21)%, 39.27% and 69.65%, respectively.
Based on the foregoing calculations, the average annual total returns
(after fee waivers) for the California Tax-Exempt Bond Fund for the one year,
five year and ten year periods ended February 28, 1995, were (4.16)%, 6.39%, and
8.04%, respectively. The aggregate total returns for the California Tax-Exempt
Bond Fund for the same three periods were (4.16)%, 36.33%, and 116.78%,
respectively.
The Funds may also advertise total return data without reflecting the
sales load imposed on the purchase of shares of the Funds in accordance with the
rules of the Securities and Exchange Commission. Quotations which do not reflect
the sales load will, of course, be higher than quotations which do.
GENERAL INFORMATION
DESCRIPTION OF SHARES
The Company is an open-end management investment company organized as a
Maryland corporation on October 27, 1982. The Fund's Charter authorizes the
Board of Directors to issue up to two hundred billion full and fractional common
shares. Pursuant to the authority granted in the Charter, the Board of Directors
has authorized the issuance of twenty-two classes of stock - Classes A through W
Common Stock, $.001 par value per share, representing interests in twenty-two
separate investment portfolios. Class D represents interests in the Aggressive
Growth Fund; Class E represents interests in the U.S. Government Securities
Fund; Class F represents interests in the Capital Income Fund; and Class G
represents interests in the California Tax-Exempt Bond Fund. The Company's
charter also authorizes the
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Board of Directors to classify or reclassify any particular class of the
Company's shares into one or more series.
Shares have no preemptive rights and only such conversion or exchange
rights as the Board may grant in its discretion. When issued for payment as
described in the Prospectuses, the Company's shares will be fully paid and
non-assessable. For information concerning possible restrictions upon the
transferability of the Company's shares and redemption provisions with respect
to such shares, see "Additional Purchase and Redemption Information."
Shareholders are entitled to one vote for each full share held, and
fractional votes for fractional shares held, and will vote in the aggregate and
not by class or series except as otherwise required by the 1940 Act or other
applicable law or when permitted by the Board of Directors. Shares have
cumulative voting rights to the extent they may be required by applicable law.
Rule 18f-2 under the 1940 Act provides that any matter required to be
submitted to the holders of the outstanding voting securities of an investment
company such as the Company shall not be deemed to have been effectively acted
upon unless approved by a majority of the outstanding shares of each Fund
affected by the matter. A Fund is affected by a matter unless it is clear that
the interests of each Fund in the matter are substantially identical or that the
matter does not affect any interest of the Fund. Under Rule 18f-2 the approval
of an investment advisory agreement or 12b-1 distribution plan or any change in
a fundamental investment policy would be effectively acted upon with respect to
a Fund only if approved by a majority of the outstanding shares of such Fund.
However, the rule also provides that the ratification of independent public
accountants, the approval of principal underwriting contracts and the election
of directors may be effectively acted upon by shareholders of the Company voting
without regard to particular Funds.
Notwithstanding any provision of Maryland law requiring a greater vote
of the Company's common stock (or of the shares of a Fund voting separately as a
class) in connection with any corporate action, unless otherwise provided by law
(for example, by Rule 18f-2 discussed above) or by the Company's Charter, the
Company may take or authorize such action upon the favorable vote of the holders
of more than 50% of the outstanding common stock of the Company voting without
regard to class.
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REPORTS
Shareholders will receive unaudited semi-annual reports describing the
Company's investment operations and annual financial statements together with
the reports of the independent accountants of the Funds.
CUSTODIAN AND TRANSFER AGENT
The Company has appointed The Bank of New York, 90 Washington Street,
New York, New York 10286, as custodian for the Funds. The Bank of New York also
provides the Funds with certain accounting services pursuant to Fund Accounting
Services Agreements with the Administrator. Under the Fund Accounting Services
Agreement, The Bank of New York has agreed to provide certain accounting,
bookkeeping, pricing, dividend and distribution calculation services with
respect to the Company. The monthly fees charged by The Bank of New York under
the Fund Accounting Agreement are borne by the Funds. As custodian of the
Company's assets, The Bank of New York (i) maintains a separate account or
accounts in the name of the respective Funds, (ii) holds and disburses portfolio
securities; (iii) makes receipts and disbursements of money, (iv) collects and
receives income and other payments and distributions on account of portfolio
securities (v) responds to correspondence from security brokers and others
relating to their respective duties and (vi) makes periodic reports concerning
their duties.
BISYS Fund Services Ohio, Inc., 3435 Stelzer Road, Columbus, Ohio
43219-3035 serves as transfer and dividend disbursing agent for the Funds.
COUNSEL
Drinker Biddle & Reath (of which W. Bruce McConnel, III, Secretary of
the Company, is a partner), 1345 Chestnut Street, Suite 1100, Philadelphia,
Pennsylvania 19107, serves as counsel to the Company and will pass upon the
legality of the shares offered hereby. O'Melveny & Myers, 400 South Hope Street,
Los Angeles, California, acts as counsel to Bank of America and as special
California counsel for the California Tax-Exempt Bond Fund and has reviewed the
portions of the California Tax-Exempt Bond Fund's Prospectus and this Statement
of Additional Information concerning California taxes and the description of the
special considerations relating to California Municipal Securities.
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INDEPENDENT ACCOUNTANTS
Price Waterhouse LLP independent accountants, with offices at 1177
Avenue of the Americas, New York, New York 10036, has been selected as
independent accountants of each Fund for the fiscal year ended February 28,
1996.
MISCELLANEOUS
As used in the Prospectuses and this Statement of Additional
Information, a "vote of a majority" of the outstanding shares of a Fund means
the affirmative vote of the lesser of (a) more than 50% of the outstanding
shares, the Portfolio of the Fund, or (b) 67% of the shares of the Fund or
series present at a meeting at which more than 50% of the outstanding shares of
the Fund are represented in person or by proxy.
At June 15, 1995, the name, address and share ownership of the entities
which held of record more than 5% of the outstanding Pacific Horizon Shares of
the Treasury Fund were as follows: BA Investment Services Inc., For the Benefit
of Clients, 555 California Street, 4th Floor, Department #4337, San Francisco,
CA 94104, 98,230,626.530 shares (7.70%); Bank of America State Trust Co., 299 N.
Euclid Avenue, Pasadena, CA 91101, 1,044,975,154.790 shares (82.00%); and
Hellman & Freidman Capital Partners II, Limited Partnership, Attention: Georgia
Lee, 1 Maritime Plaza, 12th Floor, San Francisco, CA 94111, 1,216,118,073.700
shares (095.42%).
At June 16, 1995, the name, address and share ownership of the entities
which held of record more than 5% of the outstanding Horizon Shares of the
Treasury Fund was as follows: Bank of America Trustee/Custodian for Investing in
Horizon Treasury, Attn: Eric Peterson, 701 S. Western Avenue, 2nd Floor,
Glendale, CA 91201, 398,540,438.170 shares (68.901%); Security Pacific State
Trust Co., Agreement for Sec. PACWA Participants, Attn: Cash Sweep Funds (L.
Goekjian), P.O. Box 91630, Pasadena, CA 91101, 94,279,024.120 shares (16.299%).
At June 16, 1995, the name, address and share ownership of the entities
which held beneficially more than 5% of the outstanding Horizon Service Shares
of the Treasury Fund were as follows: Bank of America FM&TS Operat CA, Attn: CTF
Unit, 701 South Western Avenue, Glendale, CA 91201, 65,745,555.320 shares
(23.658%); Bank of America Nevada Southern Comm. Bank, Attn: Dan Dykes, P.O. Box
98600, Las Vegas, NV 89193, 63,974,589.270 shares (23.020%). Security Pacific
State Trust Co., Agreement for Sec. PACWA Participants, Attn: Cash Sweep Funds,
P.O. Box 91630, Pasadena, CA 91101, 56,906,301.540 shares (20.477%); and
Security Pacific Cash Management, c/o Bank of America GPO M/C 5533, Attn: Liezel
Barangan, 1850 Gateway Boulevard, Concord, CA 94520, 77,003,300 shares
(27.709%). At June 15, 1995, the name, address
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and, share ownership of the entity which held of record more than 5% of the
outstanding Horizon Service Shares of the Treasury Fund was as follows: Omnibus
A/C for the Shareholder Accounts maintained by Concord Financial Services, Inc.,
Attn: Linda Zerbe, First and Market Building, 100 First Avenue, Suite 300,
Pittsburgh, PA 15222, 263,629,755.130 shares (65.51%). At June 15, 1995 the
name, address and share ownership of the entities which held of record more than
5% of the outstanding Pacific Horizon Shares of the Prime Fund were as follows:
BA Investment Services Inc., For the Benefit of Clients, 555 California Street,
4th Floor, Department #4337, San Francisco, CA 94104, 514,119,226.900 shares
(38.76%); Bank of America State Trust Co., 299 N. Euclid Avenue, Pasadena, CA
91101, 392,983,248.780 shares (29.63%); and Southwest Securities Inc., Attn:
Cashiering, 201 Elm Street, Suite 4300, Dallas, TX 75270, 169,018,910.270 shares
(12.74%). At June 16, 1995, the name, address and share ownership of the
entities which held of record more than 5% of the outstanding Horizon Shares of
the Prime Fund were as follows: Bank of America Trustee/Custodian for Investing
Horizon Prime, Attn: Eric Peterson, 701 S. Western Avenue, 2nd Floor, Glendale,
CA 91201, 385,058,852.030 shares (56.838%); and Bank of America NT&SA, Attn: Kay
Warren/Dept. #5596, 1455 Market Street, San Francisco, CA 94103, 57,300,000.00
shares (9.934%). At June 15, 1995, the name, address and share ownership of the
entity which held of record more than 5% of the outstanding Horizon Service
Shares of the Prime Fund were as follows: Omnibus A/C for the Shareholder
Accounts maintained by Concord Financial Services, Inc., Attn: Linda Zerbe,
First and Market Building, 100 First Avenue, Suite 300, Pittsburgh, PA 15222,
752,776,315.610 shares (70.26%).
At June 16, 1995, the name, address and share ownership of the entities
which held beneficially more than 5% of the outstanding Horizon Service Shares
of the Prime Fund were as follows: Bank of America NT&SA Financial Management
and Trust Services, 701 S. Western Avenue, Glendale, CA 91201, 74,038,082.090
shares (9.835%); Capital Network Services, Attn: Donna Novell, One Bush Street,
11th Floor, San Francisco, CA 94104, 86,407,261.23 shares (11.478%); Security
Pacific Cash Management, c/o Bank of America. GPO. M/C 5533 Attn: Liezel
Barangan, 1850 Gateway Boulevard, M/C 5533, Concord, CA 94520, 379,755,600.000
shares (50.447%); Security Pacific State Trust Co., Agreement for SecPAC WA
Participants, Attn: Cash Sweep Funds (L. Goekjian) P.O. Box 91630, Pasadena, CA
91101, 54,321,621.330 shares (7.216%); and Southwest Securities Inc., Attn: Mary
Lisenber, 1201 Elm Street, Suite 4300, Dallas, TX 75270, 130,146,660.030 shares
(17.289%).
At June 15, 1995, the name, address and share ownership of the entities
which held of record more than 5% of the outstanding Pacific Horizon Shares of
the Tax Exempt Money Fund were as follows: BA Investment Services, Inc., For the
Benefit
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of Clients, 555 California Street, 4th Floor, Department #4337, San Francisco,
CA 94104, 12,233,845.190 shares (39.73%); Southwest Securities Inc., Attn:
Cashiering, 1201 Elm Street, Suite 4300, Dallas, TX, 75270, 10,387,253.930
shares (33.73%); and Bank of America State Trust Co., 299 N. Euclid Avenue,
Pasadena, CA 91101, 6,515,635.730 shares (21.16%).
At June 16, 1995, the name, address and share ownership of the entities
which held of record more than 5% of the outstanding Horizon Shares of the Tax
Exempt Money Fund were as follows: Bank of America Custodian For Investing in
Horizon Tax Exempt Money Fund, Attn: Eric Peterson, 701 S. Western Avenue, 2nd
Floor, Glendale, CA 19201, 129,582,555.65 shares (38.576%); Continental Bank
National Association Custodian for the Benefit of Custodian Co. Attn: Mary
Chester, 231 South LaSalle Street, 6Q, Chicago, IL 60697, 152,699,416.270 shares
(45.458%); and Maine Midland Bank NA, Investment Services, 17th Floor, Attn:
Christine Mincel, One Marine Midland Center, Buffalo, NY 14203, 21,684,672.980
shares (6.455%).
At June 15, 1995, the name, address and share ownership of the entities
which held of record more than 5% of the outstanding shares of the Horizon
Service Shares of the Tax Exempt Money Fund were as follows: Furman C. Moseley
and Susan R. Moseley Tenn. In Common, 1201 3rd Avenue, Box 7C, Seattle, WA
98101, 4,165,513.060 shares (9.91%); Omnibus A/C for the shareholder accounts
maintained by Concord Financial Services Inc., Attn: Linda Zerbe, First and
Market Building, 100 First Avenue, Suite 300, Pittsburgh, PA 15222,
22,398,544.590 shares (53.31%); and Omnibus A/C for the Shareholder Accounts
maintained by Concord Financial Services Inc. Attn: First and Market Building,
100 First Avenue, Suite 300, Pittsburgh, PA 15222, 3,494,305.180 shares (8.31%).
At June 16, 1995, the name, address and share ownership of the entities which
held beneficially more than 5% of the outstanding Horizon Service Shares of the
Tax Exempt Money Fund were as follows: BA Investment Services Inc., 555
California Street, 4th Floor Dept. #4337, San Francisco, CA 94104, 1,362,028.590
shares (5.260%); Bank of America FM&TS Oper. CA, Attn: CTF Unit, 701 South
Western Avenue, Glendale, CA 91201, 2,293,907.40 shares (8.859%); and Southwest
Securities, Inc., Attn: Mary Lisenber, 1201 Elm Street, Suite 430, Dallas, TX
75270, 21,021,580.530 shares (81.187%). At June 15, 1955, the name, address and
share ownership of the entities which held of record more than 5% of the
outstanding Pacific Horizon Shares of the Government Fund were as follows: Bank
of America, NT&SA, The Private Bank, Attn: ACI Unit #8329, 701 S. Western
Avenue, Glendale, CA 91201, 79,875,532.090 shares (22.71%); Bank of America
State Trust Co., 299 N. Euclid Avenue., Pasadena, CA 91101, 64,756,966.280
shares (18.41%); and BA Investment Services Inc., For the Benefit of Clients,
555 California Street, 4th Floor, Department #4337, San Francisco, CA 94104,
170,940,404.650 shares (48.60%). At June 16, 1995, the
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name, address and share ownership of the entities which held of record more than
5% of the outstanding Horizon Shares of the Government Fund were as follows:
Bank of America NT&SA Trustee/Custodian for Investing in Horizon Shares of the
Government Fund, Attn: Cynthia Beauvais, 701 South Western Avenue., Glendale, CA
91201, 9,327,446.350 shares (5.028%); Bank of America State Trust, Attn: Rigo
Barrett, 299 N. Euclid Avenue, Pasadena, CA 91101, 28,063,486.740 shares
(15.129%); Capital Network Services, Attn: Donna Novell, One Bush Street, 11th
Floor, San Francisco, CA 94104, 24,227,801.980 shares (13.061%); County of
Orange, Matt Raabe, P.O. Box 4515, Santa Ana, CA 92702, 10,000,000.000 shares
(5.391%); Cypress Insurance Co., Attn: Larry Tetzloff, 9290 W. Dodge Road,
Omaha, NE 68124, 9,996,515.930 shares (5.389%); Harr & Co., c/o Bank of New
York, Attn: Bimal Sana, Spec. Prec. Dept., One Wall Street, 5th Floor, New York,
NY 10286, 14,000,000.000 shares (7.547%); Micron Electronics Inc., Attn: Debbie
Meigand, 900 East Karcher Road, Nanpa, ID 83687, 16,080,510.14 shares (8.669%);
and Silocin Magic Corp., Attn: Meng A. Lim, 20300 Stevens Creek Boulevard.,
Suite 400, Cupertino, CA 95014, 18,058,262.110 shares (9.735%). At June 15,
1995, the name, address and share ownership of the entities which held of record
more than 5% of the outstanding Horizon Service Shares of the Government Fund
were as follows: Spacelabs Medical, Inc., Attn: Scott Bender, P.O. Box 97013,
Redmond, WA 98073, 14,572,000.000 shares (5.70%); Good Health Plan of WA, Attn:
Tsai Cheng, 1501 9th Avenue, Suite 500, Seattle, WA 98101, 16,584,866.580 shares
(6.49%); Omnibus A/C for the Shareholder Accounts maintained by Concord.
Financial Services Inc., Attn: Linda Zerbe, First and Market Building, 100 First
Avenue, Suite 300, Pittsburgh, PA 15222, 68,555,257.020 shares (26.85%). At June
16, 1995, the name, address and share ownership of the entities which held
beneficially more than 5% of the Horizon Service Shares of the Government Fund
were as follows: Bank of America Nevada Southern Comm. Bank, Attn: Dan Dykes,
P.O. Box 98600, Las Vegas, NV 89193-8600, 35,849,966.050 shares (52.294%); and
Capital Network Services, Attn: Donna M. Howell, One Bush Street, 11th Floor,
San Francisco, CA 94104-4425, 23,929,840.440 shares (34.906%). At June 15, 1995,
the name, address and share ownership of the entities which held of record more
than 5% of the Pacific Horizon Shares of the Treasury Only Fund were as follows:
Bank of America NT&SA, the Private Bank, Attn: ACI Unit 48329, 701 South Western
Avenue, Glendale, CA 91201, 48,516,900.490 shares (31.68%) Bank of America State
Trust Co., 299 N. Euclid Avenue, Pasadena, CA 91101, 22,350,831.320 shares
(14.59%); and BA Investment Services Inc., For the Benefit of Clients, 555
California Street, 4th Floor, Department #4337, San Francisco, CA 94104,
69,016,521.500 shares (45.06%). At June 15, 1995, the name, address and share
ownership of the entities which held of record more than 5% of the outstanding
Horizon Service Shares of the Treasury Only Fund were as follows: National Home
Mortgage Corp., Attn: Mortgage Banking Treasury Operations, 5565 Morehouse
Drive, 3rd Floor, San
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Diego, CA 92121, 12,147.667,580 shares (9.42%); Comcare, Inc., 4001 N. 3rd
Street, Suite 120, Phoenix, AZ 85012, 26,230,243.620 shares (20.34%); and
Omnibus A/C For the Shareholder Accounts Maintained by Concord Financial
Services Inc., Attn: Linda Zerbe, First and Market Building, 100 First Avenue,
Suite 300, Pittsburgh, PA 15222, 21,883,084.450 shares (16.97%). At June 16,
1995, the name, address and share ownership of the entities which held
beneficially more than 5% of the outstanding Horizon Service Shares of the
Treasury Only Fund were as follows: BA Investment Service Inc., 555 California
Street, 4th Floor Dept. #4337, San Francisco, CA 94104, 6,403,628.120 shares
(28.679%); Bank of America NT&SA Trustee/Custodian for Investing in Horizon
Service Shares of the Treasury Only Fund, Attn: Cynthia Beauvais, 701 South
Western Avenue, Glendale, CA 91201, 3,501,414.020 shares (15.681%); Bank of
America State Trust, Attn: Rigo Barrett, 299 N. Euclid Avenue, Pasadena, CA
91101, 5,420,893.150 shares (24.277%); Fair Isaac & Co., Attn: Christine Tam,
120 North Redwood, San Rapheal, CA 94903-1996, 1,338,800.750 shares (5.996%);
Foothill/Eastern Transportation Corridor Agency, Attn: Laura Barker, 201 East
Sandpot, Suite 200, Santa Anna, CA 92707, 2,559,586.380 shares (11.463%); and
Nexus, Attn: Kathleen Menace, P.O. Box 60637, Sunnyvale, CA 94088-0637,
2,525,153.380 shares (11.309%). At June 15, 1995, the name, address and share
ownership of the entities which held of record more than 5% of the outstanding
Pacific Horizon Shares of the Prime Value Fund were as follows: BA Investment
Services Inc., For the Benefit of Clients, 555 California Street, 4th Floor,
Department #4337, San Francisco, CA 94104, 16,383,467.170 shares (26.45%); and
Bank of America State Trust Co., Attn: Leon Goekjian, P.O. Box 91630, Pasadena,
CA 91101, 45,078,465.290 shares (72.79%). At June 16, 1995, the name, address
and share ownership of the entity which held of record more than 5% of the
outstanding Horizon Shares of the Prime Value Fund was as follows: Tice & Co.,
c/o M&T, Attn: Cash Management Clerk, 8th Floor, P.O. Box 1377, Buffalo, NY
14240, 453,078,561.590 shares (93.510%). At June 15, 1995, the name, address and
share ownership of the entity which held of record more than 5% of the
outstanding shares of the Pacific Horizon Shares of the California Tax-Exempt
Money Market Fund was as follows: BA Investment Services Inc., For the Benefit
of Clients, 555 California Street, 4th Floor, Department #4337, San Francisco,
CA 94104, 204,443,886.590 shares (22.07%). At June 15, 1995, the name, address
and share ownership of the entities which held of record more than 5% of the
outstanding shares of the Horizon Service Shares of the California Tax-Exempt
Money Market Fund were as follows: Leo Zuckerman Trust, DTD 12-11-91,4444
Viewridge Avenue, San Diego, CA 92123, 4,850,877.280 shares (5.35%); and Omnibus
A/C for the Shareholder Accounts Maintained by Concord Financial Services Inc.
Attn: Linda Zerbe, First and Market Building, 100 First Avenue, Suite 300,
Pittsburgh, PA 15222, 13,391,453.970 shares (14.77%). At June 16, 1995, the
name, address and share ownership of the entity which held beneficially more
than 5% of the outstanding
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shares of the Horizon Service Shares of the California Tax-Exempt Money Market
Fund was as follows: BA Investment Services Inc., 555 California Street, 4th
Floor, Dept. #4337, San Francisco, CA 94109, 13,792,509.310 shares (99.206%). At
June 15, 1995, the name, address and shares ownership of the entities which held
of record more than 5% of the outstanding shares of the Flexible Bond Fund were
as follows: Peter F. Smith and Jacquelyn L. Smith, JTWROS, 1785 C. Blodgett
Road, Mount Vernon, WA 98273, 13,973.917 shares (5.58%); and BA Investment
Services, Inc., FBO 200724011, 185 Berry Street, 3rd Floor #2640, San Francisco,
CA 94104, 22,436.531 shares (8.96%). At June 15, 1995 the name, address and
share ownership of the entity which held of record more than 5% of the
outstanding shares of the Asset Allocation Fund was as follows: Bank of America,
Texas AATTEE. National-O'Neill Supplemental Savings Plan, Attn: Mutual Funds
(81-6-01005-0), P.O. Box 94627, Pasadena, CA 91109, 24,289,973 shares (5.07%).
At June 15, 1995 the name, address and share ownership of the entities which
held of record more than 5% of the outstanding shares of the National Municipal
Bond Fund were as follows: BA Investment Services, Inc. FBO 405084421, 555
California Street, 4th Floor, #2640, San Francisco, CA 94104, 26,336.154 shares
(8.31%); and BA Investment Services, Inc., FBO 405266591, 555 California Street,
4th Floor, #2640, San Francisco, CA 94104, 25,034.024 shares (7.90%). At June
15, 1995 the name, address and share ownership of the entities which held of
record more than 5% of the outstanding shares of the Corporate Bond Fund were as
follows: Dean Witter Reynolds Inc., 5 World Trade Center, 4th Floor, Attn: 5th O
Div., New York, NY 10048, 138,820.000 shares (6.93%); and Smith Barney Shearson,
Inc., 333 W. 39th Street, 8th Floor, New York, NY 10001, 148,925.482 shares
(7.43%).
At such date, no other person was known by the Company to hold of
record or beneficially more than 5% of the outstanding shares of any investment
portfolio of the Company.
The Prospectuses relating to the Funds and this Statement of Additional
Information omit certain information contained in the Company's registration
statement filed with the Securities and Exchange Commission. Copies of the
registration statement, including items omitted herein, may be obtained from the
Commission by paying the charges prescribed under its rules and regulations.
FINANCIAL STATEMENTS AND EXPERTS
The Annual Reports for each Fund for their fiscal year ended February
28, 1995 (the "Annual Reports") accompanies this Statement of Additional
Information. The financial statements and notes thereto in each Annual Report
are incorporated in this Statement of Additional Information by reference, and
have been audited by Price Waterhouse LLP, whose report thereon also
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appears in each Annual Report and is also incorporated herein by reference. Such
financial statements have been incorporated herein in reliance on the report of
Price Waterhouse LLP, independent accountants, given on the authority of said
firm as experts in auditing and accounting.
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APPENDIX A
COMMERCIAL PAPER RATINGS
A Standard & Poor's commercial paper rating is a current assessment of
the likelihood of timely payment of debt considered short-term in the relevant
market. The following summarizes the rating categories used by Standard and
Poor's for commercial paper:
"A-1" - Issue's degree of safety regarding timely payment is strong.
Those issues determined to possess extremely strong safety characteristics are
denoted "A-1+."
"A-2" - Issue's capacity for timely payment is satisfactory. However,
the relative degree of safety is not as high as for issues designated "A-1."
"A-3" - Issue has an adequate capacity for timely payment. It is,
however, somewhat more vulnerable to the adverse effects of changes and
circumstances than an obligation carrying a higher designation.
"B" - Issue has only a speculative capacity for timely payment.
"C" - Issue has a doubtful capacity for payment.
"D" - Issue is in payment default.
Moody's commercial paper ratings are opinions of the ability of issuers
to repay punctually promissory obligations not having an original maturity in
excess of 9 months. The following summarizes the rating categories used by
Moody's for commercial paper:
"Prime-1" - Issuer or related supporting institutions are considered to
have a superior capacity for repayment of short-term promissory obligations.
Prime-1 repayment capacity will normally 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.
"Prime-2" - Issuer or related supporting institutions are considered to
have a strong capacity for repayment of short-
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<PAGE> 105
term promissory 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 alternative liquidity is maintained.
"Prime-3" - Issuer or related supporting institutions have an
acceptable capacity for repayment of short-term promissory obligations. The
effects of industry characteristics and market composition may be more
pronounced. Variability in earnings and profitability may result in changes in
the level of debt protection measurements and the requirement for relatively
high financial leverage. Adequate alternate liquidity is maintained.
"Not Prime" - Issuer does not fall within any of the Prime rating
categories.
The three rating categories of Duff & Phelps for investment grade
commercial paper and short-term debt are "D-1," "D-2" and "D-3." Duff & Phelps
employs three designations, "D- 1+," "D-1" and "D-1-," within the highest rating
category. The following summarizes the rating categories used by Duff & Phelps
for commercial paper:
"D-1+" - Debt possesses 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 issue as investment grade. Risk factors are larger and subject
to more variation. Nevertheless, timely payment is expected.
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"D-4" - Debt possesses speculative investment characteristics.
Liquidity is not sufficient to ensure 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 short-term ratings apply to debt obligations that are payable on
demand or have original maturities of up to three years. The following
summarizes the rating categories used by Fitch for short-term obligations:
"F-1+" - Securities possess exceptionally strong credit quality. Issues
assigned this rating are regarded as having the strongest degree of assurance
for timely payment.
"F-1" - Securities possess very strong credit quality. Issues assigned
this rating reflect an assurance of timely payment only slightly less in degree
than issues rated "F-1+."
"F-2" - Securities possess good credit quality. Issues assigned this
rating have a satisfactory degree of assurance for timely payment, but the
margin of safety is not as great as the "F-1+" and "F-1" categories.
"F-3" - Securities possess fair credit quality. Issues assigned this
rating have characteristics suggesting that the degree of assurance for timely
payment is adequate; however, near-term adverse changes could cause these
securities to be rated below investment grade.
"F-S" - Securities possess weak credit quality. Issues assigned this
rating have characteristics suggesting a minimal degree of assurance for timely
payment and are vulnerable to near-term adverse changes in financial and
economic conditions.
"D" - Securities are in actual or imminent payment default.
Fitch may also use the symbol "LOC" with its short-term ratings to
indicate that the rating is based upon a letter of credit issued by a commercial
bank.
Thomson BankWatch short-term ratings assess the likelihood of an
untimely or incomplete payment of principal or interest of unsubordinated
instruments having a maturity of one year or less which is issued by United
States commercial banks, thrifts and non-bank banks; non-United States banks;
and broker-
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dealers. The following summarizes the ratings used by Thomson BankWatch:
"TBW-1" - This designation represents Thomson BankWatch's highest
rating category and indicates a very high degree of likelihood that principal
and interest will be paid on a timely basis.
"TBW-2" - This designation indicates that while the degree of safety
regarding timely payment 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 the lowest investment grade
category and indicates that while the debt is more susceptible to adverse
developments (both internal and external) than obligations with higher ratings,
capacity to service principal and interest in a timely fashion is considered
adequate.
"TBW-4" - This designation indicates that the debt is regarded as
non-investment grade and therefore speculative.
IBCA assesses the investment quality of unsecured debt with an original
maturity of less than one year which is issued by bank holding companies and
their principal bank subsidiaries. The following summarizes the rating
categories used by IBCA for short-term debt ratings:
"A1" - Obligations are supported by the highest capacity for timely
repayment. Where issues possess a particularly strong credit feature, a rating
of A1+ is assigned.
"A2" - Obligations are supported by a good capacity for timely
repayment.
"A3" - Obligations are supported by a satisfactory capacity for timely
repayment.
"B" - Obligations for which there is an uncertainty as to the capacity
to ensure timely repayment.
"C" - Obligations for which there is a high risk of default or which
are currently in default.
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CORPORATE AND MUNICIPAL LONG-TERM DEBT RATINGS
The following summarizes the ratings used by Standard & Poor's for
corporate and municipal debt:
"AAA" - This designation represents the highest rating assigned by
Standard & Poor's to a debt obligation and indicates an extremely strong
capacity to pay interest and repay principal.
"AA" - Debt is considered to have a very strong capacity to pay
interest and repay principal and differs from AAA issues only in small degree.
"A" - Debt is considered to have a strong capacity to pay interest and
repay principal although such issues are somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than debt in
higher-rated categories.
"BBB" - Debt is regarded as having an adequate capacity to pay interest
and repay principal. Whereas such issues normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher-rated categories.
"BB," "B," "CCC," "CC" and "C" - Debt is regarded, on balance, as
predominantly speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligation. "BB" indicates the
lowest degree of speculation and "C" the highest degree of speculation. While
such debt will likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major risk exposures to adverse
conditions.
"BB" - Debt has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure to
adverse business, financial or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. The "BB"
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied "BBB-" rating.
"B" - Debt has a greater vulnerability to default but currently has the
capacity to meet interest payments and principal repayments. Adverse business,
financial or economic conditions will likely impair capacity or willingness to
pay interest and repay principal. The "B" rating category is also used for debt
subordinated to senior debt that is assigned an actual or implied "BB" or "BB-"
rating.
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"CCC" - Debt has a currently identifiable vulnerability to default, and
is dependent upon favorable business, financial and economic conditions to meet
timely payment of interest and repayment of principal. In the event of adverse
business, financial or economic conditions, it is not likely to have the
capacity to pay interest and repay principal. The "CCC" rating category is also
used for debt subordinated to senior debt that is assigned an actual or implied
"B" or "B-" rating.
"CC" - This rating is typically applied to debt subordinated to senior
debt that is assigned an actual or implied "CCC" rating.
"C" - This rating is typically applied to debt subordinated to senior
debt which is assigned an actual or implied "CCC-" debt rating. The "C" rating
may be used to cover a situation where a bankruptcy petition has been filed, but
debt service payments are continued.
"CI" - This rating is reserved for income bonds on which no interest is
being paid.
"D" - Debt is in payment default. This rating is used when interest
payments or principal payments are not made on the date due, even if the
applicable grace period has not expired, unless S & P believes such payments
will be made during such grace period. "D" rating is also used upon the filing
of a bankruptcy petition if debt service payments 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 rating is attached to highlight derivative, hybrid, and
certain other obligations that S & P believes may experience high volatility or
high variability in expected returns due to non-credit risks. Examples of such
obligations are: securities whose principal or interest return is indexed to
equities, commodities, or currencies; certain swaps and options; and interest
only and principal only mortgage securities.
The following summarizes the ratings used by Moody's for corporate and
municipal long-term debt:
"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.
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"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 risks appear somewhat larger than in "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 considered medium-grade obligations, i.e., they are
neither highly protected nor poorly secured. Interest payments and principal
security appear adequate for the present but certain protective elements may be
lacking or may be characteristically unreliable over any 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 some speculative elements; "B" indicates a general lack of
characteristics of desirable investment; "Caa" represents a 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 (a) earnings of projects under construction, (b) earnings
of projects unseasoned in operation experience, (c) rentals which begin when
facilities are completed, or (d) payments to which some other limiting condition
attaches. Parenthetical rating denotes probable credit stature upon completion
of construction or elimination of basis of condition.
Moody's applies numerical modifiers 1, 2 and 3 in each generic
classification from "Aa" to "B" in its bond rating system. The modifier 1
indicates that the issuer ranks in the higher end of its generic rating
category; the modifier 2 indicates a mid-range ranking; and the modifier 3
indicates that the issuer ranks at the lower end of its generic rating category.
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The following summarizes the long-term debt ratings used by Duff &
Phelps 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 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 and greater in periods of 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 highest four ratings used by Fitch for
corporate and municipal bonds:
"AAA" - Bonds considered to be investment grade and of the highest
credit quality. The obligor has an exceptionally strong ability to pay interest
and repay principal, which is unlikely to be affected by reasonably foreseeable
events.
"AA" - Bonds considered to be investment grade and of very high credit
quality. The obligor's ability to pay interest and repay principal is very
strong, although not quite as strong as bonds rated "AAA." Because bonds rated
in the "AAA" and "AA" categories are not significantly vulnerable to foreseeable
future developments, short-term debt of these issuers is generally rated "F1+."
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"A" - Bonds considered to be investment grade and of high credit
quality. The obligor's ability to pay interest and repay principal is considered
to be strong, but may be more vulnerable to adverse changes in economic
conditions and circumstances than bonds with higher ratings.
"BBB" - Bonds considered to be investment grade and of satisfactory
credit quality. The obligor's ability to pay interest and repay principal is
considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have an adverse impact on these
bonds, and therefore, impair timely payment. The likelihood that the ratings of
these bonds will fall below investment grade is higher than for bonds with
higher ratings.
"BB," "B," "CCC," "CC," "C," "DDD," "DD," and "D" Bonds that possess
one of these ratings are considered by Fitch to be speculative investments. The
ratings "BB" to "C" represent Fitch's assessment of the likelihood of timely
payment of principal and interest in accordance with the terms of obligation for
bond issues not in default. For defaulted bonds, the rating "DDD" to "D" is an
assessment of the ultimate recovery value through reorganization or liquidation.
To provide more detailed indications of credit quality, the Fitch
ratings from and including "AA" to "C" may be modified by the addition of a plus
(+) or minus (-) sign to show relative standing within these major rating
categories.
IBCA assesses the investment quality of unsecured debt with an original
maturity of more than one year which is issued by bank holding companies and
their principal bank subsidiaries. The following summarizes the rating
categories used by IBCA for long-term debt ratings:
"AAA" - Obligations for which there is the lowest expectation of
investment risk. Capacity for timely repayment of principal and interest is
substantial such that adverse changes in business, economic or financial
conditions are unlikely to increase investment risk substantially.
"AA" - Obligations for which there is a very low expectation of
investment risk. Capacity for timely repayment of principal and interest is
substantial. Adverse changes in business, economic or financial conditions may
increase investment risk albeit not very significantly.
"A" - Obligations for which there is a low expectation of investment
risk. Capacity for timely repayment of principal and interest is strong,
although adverse changes in business,
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economic or financial conditions may lead to increased investment risk.
"BBB" - Obligations for which there is currently a low expectation of
investment risk. Capacity for timely repayment of principal and interest is
adequate, although adverse changes in business, economic or financial conditions
are more likely to lead to increased investment risk than for obligations in
higher categories.
"BB," "B," "CCC," "CC," and "C" - Obligations are assigned one of these
ratings where it is considered that speculative characteristics are present.
"BB" represents the lowest degree of speculation and indicates a possibility of
investment risk developing. "C" represents the highest degree of speculation and
indicates that the obligations are currently in default.
IBCA may append a rating of plus (+) or minus (-) to a rating to denote
relative status within major rating categories.
Thomson BankWatch 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 Thomson BankWatch for long-term debt ratings:
"AAA" - This designation represents the highest category assigned by
Thomson BankWatch to long-term debt and indicates that the ability to repay
principal and interest on a timely basis is very high.
"AA" - This designation indicates a superior ability to repay principal
and interest on a timely basis with limited incremental risk versus 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 Thomson BankWatch's lowest
investment grade category and indicates an acceptable capacity to repay
principal and interest. Issues rated "BBB" are, however, 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
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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.
"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 Standard and Poor'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 Standard & Poor's Ratings Group for municipal
notes:
"SP-1" - The issuers of these municipal notes exhibit very strong or
strong capacity to pay principal and interest. Those issues determined to
possess overwhelming safety characteristics are given a plus (+) designation.
"SP-2" - The issuers of these municipal notes exhibit satisfactory
capacity to pay principal and interest.
"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 Investors Service, Inc.
for short-term notes:
"MIG-1"/"VMIG-1" - Loans bearing this designation 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" - Loans bearing this designation are of high quality,
with margins of protection ample although not so large as in the preceding
group.
"MIG-3"/"VMIG-3" - Loans bearing this designation are of favorable
quality, with all security elements accounted for but lacking the undeniable
strength of the preceding grades.
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Liquidity and cash flow protection may be narrow and market access for
refinancing is likely to be less well established.
"MIG-4"/"VMIG-4" - Loans bearing this designation are of adequate
quality, carrying specific risk but having protection commonly regarded as
required of an investment security and not distinctly or predominantly
speculative.
"SG" - Loans bearing this designation are of speculative quality and
lack margins of protection.
Fitch and Duff & Phelps use the short-term ratings described under
Commercial Paper Ratings for municipal notes.
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APPENDIX B
As stated in the Prospectuses, the Aggressive Growth Fund, U.S.
Government Securities Fund and Capital Income Fund, may enter into futures
contracts and options for hedging purposes. Such transactions are described in
this Appendix B.
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 Fund may use interest rate futures as
a defense, or hedge, against anticipated interest rate changes and not for
speculation. 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 Fund 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 Fund, through using futures contracts.
Description of Interest Rate Futures Contracts. An interest rate
futures contract sale would create an obligation by a Fund, 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 Fund, 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.
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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 Fund'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
in the sale exceeds the price in the offsetting purchase, the Fund is paid the
difference and thus realizes a gain. If the offsetting purchase price exceeds
the sale price, the Fund pays the difference and realizes a loss. Similarly, the
closing out of a futures contract purchase is effected by the Fund's entering
into a futures contract sale. If the offsetting sale price exceeds the purchase
price, the Fund realizes a gain, and if the purchase price exceeds the
offsetting sale price, the Fund 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 and the
Chicago Mercantile Exchange. The Fund 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 Fund may trade in any futures contract for which
there exists a public market, including, without limitation, the foregoing
instruments.
Examples of Futures Contract Sale. A Fund would engage in an interest
rate futures contract sale to maintain the income advantage from continued
holding of a long-term bond while endeavoring to avoid part or all of the loss
in market value that would otherwise accompany a decline in long-term securities
prices. Assume that the market value of a certain security in the Capital Income
Fund tends to move in concert with the futures market prices of long-term United
States Treasury bonds ("Treasury bonds"). The investment adviser wishes to fix
the current market value of this portfolio security until some point in the
future. Assume the portfolio security has a market value of 100, and the
investment adviser believes that, because of an anticipated rise in interest
rates, the value will decline to 95. The Capital Income Fund might enter into
futures contract sales of Treasury bonds for an equivalent of 98. If the market
value of the portfolio security does indeed decline from 100 to 95, the
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equivalent futures market price for the Treasury bonds might also decline from
98 to 93.
In that case, the five-point loss in the market value of the portfolio
security would be offset by the five-point gain realized by closing out the
futures contract sale. Of course, the futures market price of Treasury bonds
might well decline to more than 93 or to less than 93 because of the imperfect
correlation between cash and futures prices mentioned below.
The investment adviser could be wrong in its forecast of interest rates
and the equivalent futures market price could rise above 98. In this case, the
market value of the portfolio securities, including the portfolio security being
protected, would increase. The benefit of this increase would be reduced by the
loss realized on closing out the futures contract sale.
If interest rate levels did not change, the Fund in the above example
might incur a loss of 2 points (which might be reduced by an off-setting
transaction prior to the settlement date). In each transaction, transaction
expenses would also be incurred.
Examples of Futures Contract Purchase. A Fund would engage in an
interest rate futures contract purchase when it is not fully invested in
long-term bonds but wishes to defer for a time the purchase of long-term bonds
in light of the availability of advantageous interim investments, e.g.,
shorter-term securities whose yields are greater than those available on
long-term bonds. The Fund's basic motivation would be to maintain for a time the
income advantage from investing in the short-term securities; the Fund would be
endeavoring at the same time to eliminate the effect of all or part of an
expected increase in market price of the long-term bonds that the Fund may
purchase.
For example, assume that the market price of a long-term bond that the
Capital Income Fund may purchase, currently yielding 10%, tends to move in
concert with futures market prices of Treasury bonds. The investment adviser
wishes to fix the current market price (and thus 10% yield) of the long-term
bond until the time (four months away in this example) when it may purchase the
bond. Assume the long-term bond has a market price of 100, and the investment
adviser believes that, because of an anticipated fall in interest rates, the
price will have risen to 105 (and the yield will have dropped to about 9 1/2%)
in four months. The Fund might enter into futures contracts purchases of
Treasury bonds for an equivalent price of 98. At the same time, the Fund would
assign a pool of investments in short-term securities that are either maturing
in four months or earmarked for sale in four months, for purchase of the
long-term bond at an assumed market price of 100. Assume these short-term
securities
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are yielding 15%. If the market price of the long-term bond does indeed rise
from 100 to 105, the equivalent futures market price for Treasury bonds might
also rise from 98 to 103. In that case, the 5-point increase in the price that
the Capital Income Fund pays for the long-term bond would be offset by the
5-point gain realized by closing out the futures contract purchase.
The investment adviser could be wrong in its forecast of interest
rates; long-term interest rates might rise to above 10%; and the equivalent
futures market price could fall below 98. If short-term rates at the same time
fall to 10% or below, it is possible that the Fund would continue with its
purchase program for long-term bonds. The market price of available long-term
bonds would have decreased. The benefit of this price decrease, and thus yield
increase, will be reduced by the loss realized on closing out the futures
contract purchase.
If, however, short-term rates remained above available long-term rates,
it is possible that the Fund would discontinue its purchase program for
long-term bonds. The yield on short-term securities in the portfolio, including
those originally in the pool assigned to the particular long-term bond, would
remain higher than yields on long-term bonds. The benefit of this continued
incremental income will be reduced by the loss realized on closing out the
futures contract purchase. In each transaction, expenses would also be incurred.
II. STOCK INDEX FUTURES CONTRACTS
A stock index assigns relative values to the stocks included in the
index and the index fluctuates with changes in the market values of the stocks
included. A stock index futures contract is a bilateral agreement pursuant to
which two parties agree to take or make delivery of an amount of cash equal to a
specified dollar amount times the difference between the stock index value
(which assigns relative values to the common stocks included in the index) at
the close of the last trading day of the contract and the price at which the
futures contract is originally struck. No physical delivery of the underlying
stocks in the index is made. Some stock index futures contracts are based on
broad market indices, such as the Standard & Poor's 500 or the New York Stock
Exchange Composite Index. In contrast, certain exchanges offer futures contracts
on narrower market indices, such as the Standard & Poor's 100 or indices 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.
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The Aggressive Growth Fund and Capital Income Fund will sell stock
index futures contracts in order to offset a decrease in market value of their
respective portfolio securities that might otherwise result from a market
decline. The Funds may do so either to hedge the value of their respective
portfolios as a whole, or to protect against declines, occurring prior to sales
of securities, in the value of the securities to be sold. Conversely, the Funds
will purchase stock index futures contracts in anticipation of purchases of
securities. In a substantial majority of these transactions, the Funds will
purchase such securities upon termination of the long futures position, but a
long futures position may be terminated without a corresponding purchase of
securities.
In addition, the Aggressive Growth Fund and Capital Income Fund may
utilize stock index futures contracts in anticipation of changes in the
composition of their respective portfolio holdings. For example, in the event
that a Fund 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. The Funds 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 their respective portfolios will decline prior to the time of
sale.
The following are examples of transactions in stock index futures (net
of commissions and premiums, if any).
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ANTICIPATORY PURCHASE HEDGE: Buy the Future
Hedge Objective: Protect Against Increasing Price
<TABLE>
<CAPTION>
Portfolio Futures
--------- -------
<S> <C>
-Day Hedge is Placed-
Anticipate Buying $62,500 Buying 1 Index Futures
Aggressive Growth Fund at 125
Value of Futures =
$62,500/Contract
-Day Hedge is Lifted-
Buy Aggressive Growth Fund with Sell 1 Index Futures at 130
Actual Cost = $65,000 Value of Futures = $65,000/
Increase in Purchase Price = Contract
$2,500 Gain on Futures = $2,500
</TABLE>
HEDGING A STOCK PORTFOLIO: Sell the Future
Hedge Objective: Protect Against Declining
Value of the Fund
Factors:
Value of Stock Fund = $1,000,000
Value of Futures Contract = 125 x $500 = $62,500
Fund Beta Relative to the Index = 1.0
<TABLE>
<CAPTION>
Portfolio Futures
--------- -------
<S> <C>
-Day Hedge is Placed-
Anticipate Selling $1,000,000 Sell 16 Index Futures at 125
Aggressive Growth Fund Value of Futures = $1,000,000
-Day Hedge is Lifted-
Aggressive Growth Fund-Own Buy 16 Index Futures at 120
Stock with Value = $960,000 Value of Futures = $960,000
Loss in Fund Value = $40,000 Gain on Futures = $40,000
</TABLE>
If, however, the market moved in the opposite direction, that is,
market value decreased and a Fund had entered into an anticipatory purchase
hedge, or market value increased and a Fund had hedged its stock portfolio, the
results of the Fund's transactions in stock index futures would be as set forth
below.
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ANTICIPATORY PURCHASE HEDGE: Buy the Future
Hedge Objective: Protect Against Increasing Price
<TABLE>
<CAPTION>
Portfolio Futures
--------- -------
<S> <C>
-Day Hedge is Placed-
Anticipate Buying $62,500 Buying 1 Index Futures at 125
Aggressive Growth Fund Value of Futures = $62,500/
Contract
-Day Hedge is Lifted-
Buy Aggressive Growth Fund with Sell 1 Index Futures at 120
Actual Cost - $60,000 Value of Futures = $60,000/
Decrease in Purchase Price = $2,500 Contract
Loss on Futures = $2,500
</TABLE>
HEDGING A STOCK PORTFOLIO: Sell the Future
Hedge Objective: Protect Against Declining
Value of the Fund
Factors:
Value of Stock Fund = $1,000,000
Value of Futures Contract = 125 x $500 = $62,500
Fund Beta Relative to the Index = 1.0
<TABLE>
<CAPTION>
Portfolio Futures
--------- -------
<S> <C>
-Day Hedge is Placed-
Anticipate Selling $1,000,000 Sell 16 Index Futures at 125
Aggressive Growth Fund Value of Futures = $1,000,000
-Day Hedge is Lifted-
Aggressive Growth Fund-Own Buy 16 Index Futures at 130
Stock with Value = $1,040,000 Value of Futures = $1,040,000
Gain in Fund Value = $40,000 Loss of Futures = $40,000
</TABLE>
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 a foreign currency, for an amount fixed in
U.S. dollars. Foreign currency futures may be used by the Aggressive Growth Fund
to hedge against exposure to fluctuations in exchange rates between the U.S.
dollar and other currencies arising from multinational transactions.
IV. MARGIN PAYMENTS
Unlike when a Fund purchases or sells a security, no price is paid or
received by the Fund upon the purchase or sale of a futures contract. Initially,
the Fund will be required to
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deposit with the broker or in a segregated account with the Fund's custodian an
amount of cash or cash equivalents, the value of which may vary but is generally
equal to 10% or less of the value of the contract. This amount is known as
initial margin. 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 Fund 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 Fund
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 Fund will be entitled to receive from the broker a
variation margin payment equal to that increase in value. Conversely, where a
Fund 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 Fund would be required to make a variation margin
payment to the broker. At any time prior to expiration of the futures contract,
the investment 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 Fund'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 Fund, and the Fund realizes a loss or gain.
V. RISKS OF TRANSACTIONS IN FUTURES CONTRACTS
There are several risks in connection with the use of futures in the
Funds as a hedging device. One risk arises because of the imperfect correlation
between movements in the price of the future and movements in the price of the
securities which are the subject of the hedge. The price of the future may move
more than or less than the price of the securities being hedged. If the price of
the future moves less than the price of the securities which are the subject of
the hedge, the hedge will not be fully effective but, if the price of the
securities being hedged has moved in an unfavorable direction, the Fund would be
in a better position than if it had not hedged at all. If the price of the
securities being hedged has moved in a favorable direction, this advantage will
be partially offset by the loss on the future. If the price of the future moves
more than the price of the hedged securities, the Fund involved will experience
either a loss or gain on the future which will not be completely
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offset by movements in the price of the securities which are the subject of the
hedge. To compensate for the imperfect correlation of movements in the price of
securities being hedged and movements in the price of futures contracts, a Fund
may buy or sell futures contracts in a greater dollar amount than the dollar
amount of securities being hedged if the volatility over a particular time
period of the prices of such securities has been greater than the volatility
over such time period of the future, or if otherwise deemed to be appropriate by
the investment adviser. Conversely, a Fund may buy or sell fewer futures
contracts if the volatility over a particular time period of the prices of the
securities 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 adviser. It is also possible that, where the Fund has sold futures to
hedge its portfolio against a decline in the market, the market may advance and
the value of securities held in the Fund may decline. If this occurred, the Fund
would lose money on the future and also experience a decline in value in its
portfolio securities.
Where futures are purchased to hedge against a possible increase in the
price of securities before a Fund is able to invest its cash (or cash
equivalents) in securities (or options) in an orderly fashion, it is possible
that the market may decline instead; if the Fund then concludes not to invest in
securities or options at that time because of concern as to possible further
market decline or for other reasons, the Fund will realize a loss on the futures
contract that is not offset by a reduction in the price of securities purchased.
In instances involving the purchase of futures contracts by a Fund, an
amount of cash and cash equivalents, equal to the market value of the futures
contracts, will be deposited in a segregated account with the Fund's custodian
and/or in a margin account with a broker to collateralize the position.
In addition to the possibility that there may be an imperfect
correlation, or no correlation at all, between movements in the futures and the
securities being hedged, the price of futures may not correlate perfectly with
movement in the cash market due to certain market distortions. 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
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<PAGE> 125
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 Funds
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 Fund 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.
Successful use of futures by a Fund is also subject to the investment
adviser's ability to predict correctly movements in the direction of the market.
For example, if a Fund has hedged against the possibility of a decline in the
market adversely affecting securities held by it and securities prices increase
instead, the Fund will lose part of 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 Fund has insufficient
cash, it may have to sell securities to meet daily variation margin
requirements. Such sales of securities may be, but will
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<PAGE> 126
not necessarily be, at increased prices which reflect the rising market. A Fund
may have to sell securities at a time when it may be disadvantageous to do so.
VI. OPTIONS ON FUTURES CONTRACTS
Each Fund may purchase 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.
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). In addition, the purchase
of an option also entails the risk that changes in the value of the underlying
futures contract will not be fully reflected 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 Funds because the maximum amount at risk is the premium
paid for the options (plus transaction costs). Although permitted by their
fundamental investment policies, the Funds do not currently intend to write
futures options, and will not do so in the future absent any necessary
regulatory approvals.
VII. OTHER HEDGING TRANSACTIONS
The U.S. Government Securities Fund and Capital Income Fund presently
intend to use interest rate futures contracts, the Aggressive Growth Fund
presently intends to use stock index futures contract and foreign currency
futures contracts (and related options) in connection with their hedging
activities. Nevertheless, each of these Funds is authorized to enter into
hedging transactions in any other futures or options contracts which are
currently traded or which may subsequently become
B-11
<PAGE> 127
available for trading. Such instruments may be employed in connection with the
Funds' hedging strategies if, in the judgment of the investment adviser,
transactions therein are necessary or advisable.
VIII. ACCOUNTING AND TAX TREATMENT
Accounting for futures contracts and related options will be in
accordance with generally accepted accounting principles.
Generally, futures contracts and options on futures contracts held by a
Fund at the close of the Fund's taxable year will be treated for federal income
tax purposes as sold for their fair market value on the last business day of
such year, a process known as "marking-to-market." Forty percent of any gain or
loss resulting from such constructive sale will be treated as short-term capital
gain or loss and 60% of such gain or loss will be treated as long-term capital
gain or loss without regard to the length of time the Fund holds the futures
contract or option ("the 40%-60% rule"). The amount of any capital gain or loss
actually realized by a Fund in a subsequent sale or other disposition of those
futures contracts or options will be adjusted to reflect any capital gain or
loss taken into account by a Fund in a prior year as a result of the
constructive sale of the contracts or options. With respect to futures contracts
to sell, which will be regarded as parts of a "mixed straddle" because their
values fluctuate inversely to the values of specific securities held by a Fund,
losses as to such contracts to sell will be subject to certain loss deferral
rules which limit the amount of loss currently deductible on either part of the
straddle to the amount thereof which exceeds the unrecognized gain (if any) with
respect to the other part of the straddle, and to certain wash sales
regulations. Under short sales rules, which also will be applicable, the holding
period of the securities forming part of the straddle (if they have not been
held for the long-term holding period) will be deemed not to begin prior to
termination of the straddle. With respect to certain futures contracts and
related options, deductions for interest and carrying charges will not be
allowed. Notwithstanding the rules described above, with respect to futures
contracts to sell which are properly identified as such, a Fund may make an
election which will exempt (in whole or in part) those identified futures
contracts from being treated for federal income tax purposes as sold on the last
business day of the Fund's taxable year, but gains and losses will be subject to
such short sales, wash sales and loss deferral rules and the requirement to
capitalize interest and carrying charges. Under Temporary Regulations, a Fund
would be allowed (in lieu of the foregoing) to elect either (1) to offset gains
or losses from portions which are part of a mixed straddle by separately
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<PAGE> 128
identifying each mixed straddle to which such treatment applies, or (2) to
establish a mixed straddle account for which gains and losses would be
recognized and offset on a periodic basis during the taxable year. Under either
election, the 40%-60% rule will apply to the net gain or loss attributable to
the futures contracts, but in the case of a mixed straddle account election, not
more than 50 percent of any net gain may be treated as long-term and no more
than 40 percent of any net loss may be treated as short-term.
Certain foreign currency contracts entered into by the Aggressive
Growth Fund may be subject to the "marking-to-market" process, but gain or loss
will be treated as 100% ordinary income or loss. To receive such federal income
tax treatment, a foreign currency contract must meet the following conditions:
(1) the contract must require delivery of a foreign currency of a type in which
regulated futures contracts are traded or upon which the settlement value of the
contract depends; (2) the contract must be entered into at arm's length at a
price determined by reference to the price in the interbank market; and (3) the
contract must be traded in the interbank market. The Treasury Department has
broad authority to issue regulations under the provisions respecting foreign
currency contracts. As of the date of this Statement of Additional Information,
the Treasury has not issued any such regulations. Foreign currency contracts
entered into by the Fund may result in the creation of one or more straddles for
federal income tax purposes, in which case certain loss deferral, short sales,
and wash sales rules and the requirement to capitalize interest and carrying
charges may apply.
With respect to the Aggressive Growth Fund and Capital Income Fund,
some investments may be subject to special rules which govern the federal income
tax treatment of certain transactions denominated in terms of a currency other
than the U.S. dollar or determined by reference to the value of one or more
currencies other than the U.S. dollar. The types of transactions covered by the
special rules include the following: (i) the acquisition of, or becoming the
obligor under, a bond or other debt instrument (including, to the extent
provided in Treasury regulations, preferred stock); (ii) the accruing of certain
trade receivables and payables; and (iii) the entering into or acquisition of
any forward contract, futures contract, option and similar financial instrument.
However, regulated futures contracts and non-equity options are generally not
subject to the special currency rules if they are or would be treated as sold
for their fair market value at year-end under the marking-to-market rules,
unless an election is made to have such currency rules apply. The disposition of
a currency other than the U.S. dollar by a U.S. taxpayer is also treated as a
transaction subject to the special currency rules. With respect
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to transactions covered by the special rules, foreign currency gain or loss is
calculated separately from any gain or loss on the underlying transaction and is
normally taxable as ordinary gain or loss. A taxpayer may elect to treat as
capital gain or loss foreign currency gain or loss arising from certain
identified forward contracts, futures contracts and options that are capital
assets in the hands of the taxpayer and which are not part of a straddle. In
accordance with Treasury regulations, certain transactions subject to the
special currency rules that are part of a "section 988 hedging transaction" (as
defined in the Code and the Treasury regulations) will be integrated and treated
as a single transaction or otherwise treated consistently for purposes of the
Code. "Section 988 hedging transactions" are not subject to the mark-to-market
or loss deferral rules under the Code. It is anticipated that some of the
non-U.S. dollar denominated investments and foreign currency contracts that such
Funds may make or may enter into will be subject to the special currency rules
described above. Gain or loss attributable to the foreign currency component of
transactions engaged in by a Fund which are not subject to special currency
rules (such as foreign equity investments other than certain preferred stocks)
will be treated as capital gain or loss and will not be segregated from the gain
or loss on the underlying transaction.
Qualification as a regulated investment company under the Code requires
that each Fund satisfy certain requirements with respect to the source of its
income during a taxable year. At least 90% of the gross income of each Fund must
be derived from dividends, interests, payments with respect to securities loans,
gains from the sale or other disposition of stock, securities or foreign
currencies, and other income (including but not limited to gains from options,
futures, or forward contracts) derived with respect to the Fund's business of
investing in such stock, securities or currencies. The Treasury Department may
by regulation exclude from qualifying income foreign currency gains which are
not directly related to a Fund's principal business of investing in stock or
securities, or options and futures with respect to stock or securities. Any
income derived by a Fund from a partnership or trust is treated for this purpose
as derived with respect to the Fund's business of investing in stock, securities
or currencies only to the extent that such income is attributable to items of
income which would have been qualifying income if realized by the Fund in the
same manner as by the partnership or trust.
An additional requirement for qualification as a regulated investment
company under the Code is that less than 30% of a Fund's gross income must be
derived from gains realized on the sale or other disposition of the following
investments held for less than three moths: (1) stock and securities (as defined
in section 2(a)(36) of the 1940 Act); (2) options, futures and
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forward contracts other than those on foreign currencies; and (3) foreign
currencies (and options, futures and forward contracts on foreign currencies)
that are not directly related to a Fund's principal business of investing in
stock and securities (and options and futures with respect to stocks and
securities). With respect to futures contracts and other financial instruments
subject to the marking-to-market rules, the Internal Revenue Service has ruled
in private letter rulings that a gain realized from such a futures contract or
financial instrument will be treated as being derived from a security held for
three months or more (regardless of the actual period for which the contract or
instrument is held) if the gain arises as a result of a constructive sale under
the marking-to-market rules, and will be treated as being derived from a
security held for less than three months only if the contract or instrument is
terminated (or transferred) during the taxable year (other than by reason of
marking-to-market) and less than three months have elapsed between the date the
contract or instrument is acquired and the termination date. In determining
whether the 30% test is met for a taxable year, increases and decreases in the
value of each Fund's futures contracts and other investments that qualify as
part of a "designated hedge," as defined in the Code, may be netted.
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PACIFIC HORIZON FUNDS, INC.
(THE "COMPANY")
PART B
STATEMENT OF ADDITIONAL INFORMATION
FOR
FLEXIBLE BOND FUND
BLUE CHIP FUND
ASSET ALLOCATION FUND
July 1, 1995
(as Revised March 8, 1996)
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
<S> <C>
The Company............................................ 2
Investment Objectives And Policies..................... 2
Additional Purchase And Redemption Information......... 21
Additional Information Concerning Taxes................ 30
Management............................................. 33
General Information.................................... 58
Appendix A............................................. A-1
Appendix B............................................. B-1
</TABLE>
This Statement of Additional Information applies to the Pacific Horizon
Flexible Bond Fund ("Flexible Bond Fund"), Pacific Horizon Blue Chip Fund ("Blue
Chip Fund") and Pacific Horizon Asset Allocation Fund ("Asset Allocation Fund")
of the Company. This Statement of Additional Information is meant to be read in
conjunction with the Prospectuses dated July 1, 1995, as they may from time to
time be revised (individually, a "Prospectus" and collectively, the
"Prospectuses"), which describe the particular Fund of the Company in which the
investor is interested. This Statement of Additional Information is incorporated
by reference in its entirety into each such Prospectus. Because this Statement
of Additional Information is not itself a prospectus, no investment in shares of
any Fund should be made solely upon the information contained herein. Copies of
the Prospectuses relating to the Company's Funds to which this Statement of
Additional Information relates may be obtained by calling Concord Financial
Group, Inc. at 800-332-3863. Capitalized terms used but not defined herein have
the same meaning as in the Prospectuses.
<PAGE> 132
THE COMPANY
The Company was organized on October 27, 1982 as a Maryland
corporation. The Flexible Bond, Blue Chip and Asset Allocation Funds commenced
operations January 24, 1994, January 13, 1994 and January 18, 1994,
respectively. The Flexible Bond, Blue Chip and Asset Allocation Funds seek to
achieve their respective investment objectives by investing substantially all of
their assets in diversified investment portfolios (the "Portfolios") of an
open-end, management investment company having the same investment objective as
these Funds.
The Company also offers other investment portfolios which are described
in separate Prospectuses and Statements of Additional Information. For
information concerning these other portfolios contact the Distributor at the
telephone number stated on the cover page of this Statement of Additional
Information.
INVESTMENT OBJECTIVES AND POLICIES
The Prospectus for each Fund describes the investment objective of each
Fund and its corresponding Portfolio. Since the investment characteristics of
each Fund will correspond with its respective Portfolio, the following is a
discussion of the various investments and techniques employed by each Portfolio.
The following information supplements and should be read in conjunction with the
descriptions of the investment objective and policies in the Prospectus for each
Fund.
PORTFOLIO TRANSACTIONS
The portfolio turnover rate described in each Prospectus is calculated
by dividing the lesser of purchases or sales of portfolio securities for the
year by the monthly average value of the portfolio securities. The calculation
excludes all securities whose maturities at the time of acquisition were one
year or less. Portfolio turnover may vary greatly from year to year as well as
within a particular year, and may also be affected by cash requirements for
redemptions of shares and by requirements which enable the Company to receive
certain favorable tax treatment. Portfolio turnover will not be a limiting
factor in making portfolio decisions. For the fiscal year ended February 28,
1995, the portfolio turnover rates for the Portfolios corresponding to the
Flexible Bond, Blue Chip and Asset Allocation Funds were 240%, 44% and 142%,
respectively. For the period from December 6, 1993 (commencement of operations)
to February 28, 1994, the portfolio turnover rates for the Portfolio's
corresponding to the Flexible Bond, Blue Chip and Asset Allocation Funds were
32%, 86% and 67%, respectively.
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<PAGE> 133
Subject to the general control of the Portfolios' Board of Trustees,
Bank of America National Trust and Savings Association ("Bank of America" or the
"investment adviser") is responsible for, makes decisions with respect to, and
places orders for, all purchases and sales of portfolio securities for each
Portfolio.
Transactions on stock exchanges involve the payment of negotiated
brokerage commissions. There is generally no stated commission in the case of
securities traded in the over-the-counter market, but the price includes an
undisclosed commission or mark-up. The cost of 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. Purchases and sales of portfolio securities for the
Portfolio corresponding to the Flexible Bond Fund and the fixed income portion
of the Portfolio corresponding to the Asset Allocation Fund are normally
principal transactions without brokerage commissions. During the fiscal year
ended February 28, 1995, the Portfolios corresponding to the Blue Chip and Asset
Allocation Funds paid $202,817 and $152,778, respectively, in brokerage
commissions. For the period from December 6, 1993 (commencement of operations)
to February 28, 1994, the Portfolio's corresponding to the Blue Chip and Asset
Allocation Funds paid $270,323 and $21,798, respectively, in brokerage
commissions.
In executing portfolio transactions and selecting brokers or dealers,
it is the Portfolios' policy to seek the best overall terms available. The
Investment Advisory Agreement between the respective Portfolios and Bank of
America provides that, in assessing the best overall terms available for any
transaction, Bank of America shall consider factors it deems 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, for the specific transaction and on a
continuing basis. In addition, the Investment Advisory Agreement authorizes Bank
of America, subject to the approval of the Board of Trustees of the Portfolios
to cause the Portfolios to pay a broker-dealer which furnishes brokerage and
research services a higher commission than that which might be charged by
another broker-dealer for effecting the same transaction, provided that such
commission is deemed reasonable in terms of either that particular transaction
or the overall responsibilities of Bank of America to the particular Fund or
Portfolio. Brokerage and research services may include: (1) advice as to the
value of securities, the advisability of investing in, purchasing or selling
securities and the availability of securities or purchasers or sellers of
securities; and (2) analyses and reports
- 3 -
<PAGE> 134
concerning industries, securities, economic factors and trends, portfolio
strategy and the performance of accounts.
It is possible that certain of the brokerage and research services
received will primarily benefit one or more other investment companies or other
accounts for which investment discretion is exercised. Conversely, the Company
or any given Fund or Portfolio may be the primary beneficiary of the brokerage
or research services received as a result of portfolio transactions effected for
such other accounts or investment companies.
Brokerage and research services so received are in addition to and not
in lieu of services required to be performed by Bank of America and do not
reduce the advisory fee payable to Bank of America. Such services may be useful
to Bank of America in serving both the Company, the Portfolios and other clients
and, conversely, services obtained by the placement of business of other clients
may be useful to Bank of America in carrying out its obligations to the Company
and the Portfolios. In connection with its investment management services with
respect to the Funds and the Portfolios, Bank of America will not acquire
certificates of deposit or other securities issued by it or its affiliates, and
will give no preference to certificates of deposit or other securities issued by
Service Organizations. In addition, portfolio securities in general will be
purchased from and sold to affiliates of the Company, the Portfolios, Bank of
America, the Distributor and their affiliates acting as principal, underwriter,
syndicate member, market-maker, dealer, broker or in any similar capacity,
provided such purchase, sale or dealing is permitted under the Investment
Company Act of 1940 (the "1940 Act") and the rules thereunder.
The underlying Portfolios of the Flexible Bond, Blue Chip and Asset
Allocation Funds, may participate, if and when practicable, in bidding for the
purchase of securities of the U.S. Government and its agencies and
instrumentalities directly from an issuer in order to take advantage of the
lower purchase price available to members of a bidding group. A Portfolio will
engage in this practice only when Bank of America, in its sole discretion,
subject to guidelines adopted by the Board of Trustees of the Portfolios,
believes such practice to be in the interest of the Portfolios.
To the extent permitted by law, Bank of America may aggregate the
securities to be sold or purchased on behalf of the Portfolios with those to be
sold or purchased for other investment companies or common trust funds in order
to obtain best execution.
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The Company is required to identify any securities of its regular
brokers or dealers (as defined in Rule 10b-1 under the 1940 Act) or their
parents held by the Company as of the close of its most recent fiscal year. As
of February 28, 1995: (a) the Treasury Fund held the following securities,
Repurchase Agreement with Goldman, Sachs & Co. in the principal amount of
$95,000,000; Repurchase Agreement with Merrill Lynch Government Securities, Inc.
in the principal amount of $95,000,000; (b) the Prime Fund held the following
securities, Merrill Lynch & Co., Inc., commercial paper in the principal amount
of $100,000,000; Goldman, Sachs Group L.P., Daily Variable Rate Master Note in
the principal amount of $120,000,000; Morgan Stanley Group, Inc., Daily Variable
Rate Master Note in the principal amount of $120,000,000; Bear Stearns Co.,
Inc., Series B, Monthly Variable Rate Note in the principal amount of
$100,000,000; Repurchase Agreement with Goldman, Sachs & Co. in the principal
amount of $120,000,000; (c) the Government Fund held the following securities,
Repurchase Agreement with Goldman, Sachs & Co. in the principal amount of
$40,000,000; Repurchase Agreement with Merrill Lynch Government Securities, Inc.
in the principal amount of $40,000,000; and (d) the Prime Value Fund held the
following securities, Merrill Lynch & Co., Inc., commercial paper in the
principal amount of $7,000,000; Goldman, Sachs Group L.P., Daily Variable Rate
Master Note in the principal amount of $7,000,000; Repurchase Agreement with
Dean Witter Reynolds, Inc. in the principal amount of $8,000,000; Repurchase
Agreement with Goldman, Sachs & Co. in the principal amount of $8,000,000.
Merrill Lynch & Co., Inc., Goldman, Sachs & Co., Bear Stearns Co.,
Inc., Morgan Stanley & Co. Incorporated, Shearson Lehman Brothers, Inc., Dean
Witter Reynolds, Inc. and Paine Webber are considered to be regular brokers and
dealers of the Company.
TYPES OF OBLIGATIONS, INVESTMENT RISKS, AND OTHER INVESTMENT
INFORMATION
The following discussion supplements the descriptions of such
investments in the Prospectuses.
Bank Certificates of Deposit, Bankers' Acceptances and Time Deposits.
Certificates of deposit, bankers' acceptances and time deposits are eligible
investments for each of the Portfolios as described in the Funds' Prospectuses.
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
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the face value of the instrument on maturity. Certificates of deposit and
bankers acceptances will be obligations of domestic or foreign banks or
financial institutions with total assets at the time of purchase in excess of
$2.5 billion (including assets of both domestic and foreign branches). Time
deposits are non-negotiable deposits maintained at a banking institution for a
specified period of time at a specified interest rate. Obligations issued by the
International Bank for Reconstruction and Development, the Asian Development
Bank or the Inter-American Development Bank are not permissible investments for
the Portfolios.
Instruments issued by foreign banks or financial institutions may be
subject to investment risks that are different in some respects than the risks
associated with instruments issued by those U.S. domestic issuers. Such risks
include future political and economic developments, the possible imposition of
withholding taxes by the particular country in which the issuer is located on
interest income payable on the securities, the possible seizure or
nationalization of foreign deposits, the possible establishment of exchange
controls or the adoption of other foreign governmental restrictions which might
adversely affect the payment of principal and interest on these securities.
Domestic banks and foreign banks are subject to different governmental
regulations with respect to the amount and types of loans which may be made and
interest rates which may be charged. In addition, the profitability of the
banking industry is dependent largely upon the availability and cost of funds
for the purpose of financing lending operations under prevailing money market
conditions. General economic conditions as well as exposure to credit losses
arising from possible financial difficulties of borrowers play an important part
in the operations of the banking industry.
As a result of federal and state laws and regulations, domestic banks
are, among other things, required to maintain specified levels of reserves,
limited in the amount which they can loan to a single borrower, and subject to
other regulations designed to promote financial soundness. However, such laws
and regulations do not necessarily apply to foreign bank obligations.
Commercial Paper and Short-Term Notes. The investment policies of the
Portfolios permit investment in commercial paper and short-term notes.
Commercial paper consists of unsecured promissory notes issued by corporations.
Except as noted below with respect to variable and floating rate instruments,
issues of commercial paper and short-term notes will normally have
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maturities of less than 9 months and fixed rates of return, although such
instruments may have maturities of up to one year.
Commercial paper and short-term notes will consist of issues rated at
the time of purchase A-2 or higher by Standard & Poor's Ratings Group, Division
of McGraw Hill ("S&P"), Prime-2 or higher by Moody's Investors Service, Inc.
("Moody's"), or similarly rated by another nationally recognized statistical
rating organization ("NRSRO"); or if unrated, will be determined by Bank of
America to be of comparable quality under procedures established by the Board of
Trustees of the Portfolios. These rating symbols are described in Appendix A.
Money Market Funds. The Portfolios may under certain circumstances
invest a portion of their assets in certain money market funds. The 1940 Act
prohibits each such Portfolio from investing more than 5% of the value of its
total assets in any one investment company, or more than 10% of the value of its
total assets in investment companies as a group, and also restricts its
investment in any investment company to 3% of the voting securities of such
investment company. Investment in a money market fund will involve payment of
the Portfolio's pro rata share of advisory and administration fees charged by
such fund, in addition to those paid by the Portfolio.
Repurchase Agreements. Each Portfolio is permitted to enter into
repurchase agreements with respect to its portfolio securities. Pursuant to such
agreements, a Portfolio acquires securities from financial institutions such as
banks and broker-dealers as are deemed to be creditworthy subject to the
seller's agreement to repurchase and the agreement of the Portfolio to resell
such securities at a mutually agreed upon date and price. Repurchase agreements
maturing in more than seven days will not exceed 10% of the value of the total
assets of that Portfolio. The Portfolios are not permitted to enter into
repurchase agreements with Bank of America or its affiliates, and will give no
preference to repurchase agreements with Service Organizations. The repurchase
price generally equals the price paid by a Portfolio plus interest negotiated on
the basis of current short-term rates (which may be more or less than the rate
on the underlying portfolio security). Securities subject to repurchase
agreements will be held by a custodian or sub-custodian of the Portfolio or in
the Federal Reserve/Treasury Book-Entry System. The seller under a repurchase
agreement will be required to deliver instruments the value of which is 102% of
the repurchase price (excluding accrued interest), provided that notwithstanding
such requirement, the adviser shall require that the value of the collateral,
after transactions costs (including loss of interest) reasonably expected to be
incurred on a default, shall be equal to or greater than the resale price
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(including interest) provided in the agreement. If the seller defaulted on its
repurchase obligation, a Portfolio would suffer a loss because of adverse market
action or to the extent that the proceeds from a sale of the underlying
securities were less than the repurchase price under the agreement. Bankruptcy
or insolvency of such a defaulting seller may cause the particular Portfolio's
rights with respect to such securities to be delayed or limited. Repurchase
agreements are considered to be loans by a Portfolio under the 1940 Act.
U.S. Government Obligations. Each Portfolio is permitted to make
investments in U.S. Government obligations. Such obligations include Treasury
bills, certificates of indebtedness, notes and bonds, and issues of such
entities as the Government National Mortgage Association, Export-Import Bank of
the United States, Tennessee Valley Authority, Resolution Funding Corporation,
Farmers Home Administration, Federal Home Loan Banks, Federal Intermediate
Credit Banks, Federal Farm Credit Banks, Federal Land Banks, Federal Housing
Administration, Federal National Mortgage Association, Federal Home Loan
Mortgage Corporation, and the Student Loan Marketing Association. Treasury bills
have maturities of one year or less, Treasury notes have maturities of one to
ten years and Treasury bonds generally have maturities of more than ten years.
Some of these obligations, such as those of the Government National Mortgage
Association, are supported by the full faith and credit of the U.S. Treasury;
others, such as those of the Export-Import Bank of the United States, are
supported by the right of the issuer to borrow from the Treasury; others, such
as those of the Federal National Mortgage Association, are supported by the
discretionary authority of the U.S. Government to purchase the agency's
obligations; still others, such as those of the Student Loan Marketing
Association, are supported only by the credit of the instrumentality. No
assurance can be given that the U.S. Government would provide financial support
to U.S. Government sponsored instrumentalities if it is not obligated to do so
by law.
Variable and Floating Rate Instruments. The Portfolios may acquire
variable and floating rate instruments. Such instruments are frequently not
rated by credit rating agencies. However, in determining the creditworthiness of
unrated variable and floating rate instruments and their eligibility for
purchase by a Portfolio, Bank of America will consider the earning power, cash
flow and other liquidity ratios of the issuers of such instruments (which
include financial, merchandising, bank holding and other companies) and will
continuously monitor their financial condition. An active secondary market may
not exist with respect to particular variable or floating rate instruments
purchased by a Portfolio. The absence of such an active
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secondary market could make it difficult to dispose of a variable or floating
rate instrument in the event the issuer of the instrument defaulted on its
payment obligation or during periods that the Portfolio is not entitled to
exercise its demand rights, and the Portfolio could, for these or other reasons,
suffer a loss to the extent of the default. Investments in illiquid variable and
floating rate instruments (instruments which are not payable upon seven days'
notice and do not have active trading markets) are subject to a Portfolio's
fundamental 10% limitation on illiquid securities. Variable and floating rate
instruments may be secured by bank letters of credit.
Reverse Repurchase Agreements. The Portfolios are permitted to borrow
funds for temporary purposes by entering into reverse repurchase agreements with
such financial institutions as banks and broker-dealers in accordance with the
investment limitations described therein. Whenever a Portfolio enters into a
reverse repurchase agreement, it will place in a segregated account maintained
with its custodian liquid assets such as cash, U.S. Government securities or
other liquid high grade debt securities having a value equal to the repurchase
price (including accrued interest) and Bank of America will subsequently
continuously monitor the account for maintenance of such equivalent value. The
Portfolios intend to enter into reverse repurchase agreements to avoid otherwise
having to sell securities during unfavorable market conditions in order to meet
redemptions. Reverse repurchase agreements are considered to be borrowings by a
Portfolio under the 1940 Act.
Options Trading. The Portfolios may each purchase put and call options.
Such options may relate to particular securities or to various stock indices.
The Portfolios presently intend that the aggregate value of any Portfolio's
assets subject to options will not exceed 5% of the value of its net assets. The
investment policies of the Portfolios provides that the aggregate value of any
Portfolio's assets subject to options may not exceed 25% of the value of its net
assets.
Options trading is a highly specialized activity which entails greater
than ordinary investment risks. Regardless of how much the market price of the
underlying security or index increases or decreases, the option buyer's risk is
limited to the amount of the original investment for the purchase of the option.
However, options 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.
A listed call option for a particular security gives the purchaser of the option
the right to buy from a clearing corporation, and a writer has the obligation to
sell to the clearing corporation the
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underlying security at the stated exercise price at any time prior to the
expiration of the option, regardless of the market price of the security. The
premium paid to the writer is in consideration for undertaking the obligations
under the option contract. A listed put option gives the purchaser the right to
sell to a clearing corporation the underlying security at the stated exercise
price at any time prior to the expiration date of the option, regardless of the
market price of the security. In contrast to an option on a particular security,
an option on a stock 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.
A Portfolio will continue to receive interest or dividend income on the
securities underlying such puts until they are exercised by the Portfolio. Any
losses realized by a Portfolio in connection with its purchase of put options
will be limited to the premiums paid by the Portfolio for the options plus any
transaction costs. A gain or loss may be wholly or partially offset by a change
in the value of the underlying security which the Portfolio owns.
The Portfolios are permitted to write call options if they are
"covered." In the case of a call option on a security, the option is "covered"
if a Portfolio owns the security underlying the call or has an absolute and
immediate right to acquire that security without additional cash consideration
(or, if additional cash consideration is required, cash or cash equivalents in
such amount as are held in a segregated account by its custodian) 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 cash or
cash equivalents equal to the contract value. A call option is also covered if a
Portfolio holds a call on the same security 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 difference is maintained by the Portfolio in cash or cash
equivalents in a segregated account with its custodian.
The principal reason for writing call options on a securities portfolio
is the attempt to realize, through the receipt of premiums, a greater current
return than would be realized on the securities alone. In return for the
premium, the covered option writer gives up the opportunity for profit from a
price increase in the underlying security above the exercise price so long as
his obligation as a writer continues, but
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retains the risk of loss should the price of the security decline. Unlike one
who owns securities not subject to an option, the covered option writer has no
control over when it may be required to sell its securities, since it may be
assigned an exercise notice at any time prior to the expiration of its
obligation as a writer.
If a Portfolio desires to sell a particular security it owns, on which
it has written an option, the Portfolio will seek to effect a closing purchase
transaction prior to, or concurrently with, the sale of the security. In order
to close out a covered call option position, a Portfolio will enter into a
"closing purchase transaction" - the purchase of a call option on a security or
stock index with the same exercise price and expiration date as the call option
which it previously wrote on the same security or index. If a Portfolio is
unable to effect a closing purchase transaction, it will not be able to sell a
security on which a call option has been written until the option expires or a
Portfolio delivers the underlying security upon exercise.
When a Portfolio purchases a put or call option, the premium paid by it
is recorded as an asset of the Portfolio. When a 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 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 average of the closing bid and
asked prices. If an option purchased by a Portfolio expires unexercised, the
Portfolio realizes a loss equal to the premium paid. If a Portfolio enters into
a closing sale transaction on an option purchased by it, the Portfolio will
realize a gain if the premium received by it on the closing transaction is more
than the premium paid to purchase the option, or a loss if it is less. Moreover,
because increases in the market price of an option will generally reflect
(although not necessarily in direct proportion) increases in the market price of
the underlying security any loss resulting from a closing purchase transaction
is likely to be offset in whole or in part by appreciation of the underlying
security owned by the Portfolio. If an option written by a 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 a Portfolio is exercised, the proceeds of the sale will be
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increased by the net premium originally received and the Portfolio will realize
a gain or loss.
As noted previously, there are several risks associated with
transactions in options on securities and indices. For example, there are
significant differences between the securities 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, may be absent for reasons which include the
following: there may be insufficient trading interest in certain options;
restrictions may be imposed by a national securities exchange ("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; 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 volume; 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.
A decision as to whether, when and how to use options involves the
exercise of skill and judgment, and even a well-conceived transaction may be
unsuccessful to some degree because of market behavior or unexpected events.
Futures. The Portfolio corresponding to the Asset Allocation Fund may
purchase and sell both interest rate and stock index futures contracts (as well
as purchase related options). Similarly, the Portfolio corresponding to the
Flexible Bond Fund may purchase and sell interest rate futures contracts (as
well as purchase related options) and the Portfolio corresponding to the Blue
Chip Fund may purchase and sell stock index futures contracts (as well as
related options).
A futures contract is a bilateral agreement pursuant to which two
parties agree to take or make delivery of an amount of cash equal to a specified
dollar amount times the difference between the value of a specified obligation
or stock index (which assigns relative values to the common stocks included in
the index) at the close of the last trading day of the contract and the price at
which the futures contract is originally struck. No physical delivery of the
underlying securities is normally made.
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A Portfolio may not purchase or sell futures contracts and purchase related
options unless immediately after any such transaction the aggregate initial
margin that is required to be posted by that Portfolio under the rules of the
exchange on which the futures contract (or futures option) is traded, plus any
premiums paid by the Portfolio on its open futures options positions, does not
exceed 5% of the Portfolio's total assets, after taking into account any
unrealized profits and losses on the Portfolio's open contracts and excluding
the amount that a futures option is "in-the-money" at the time of purchase. An
option to buy a futures contract is "in-the-money" if the then current purchase
price of the contract that is subject to the option is less than the exercise or
strike price; an option to sell a futures contract is "in-the-money" if the
exercise or strike price exceeds the then current purchase price of the contract
that is the subject of the option.
Successful use of futures contracts by a Portfolio is subject to Bank
of America's ability to predict correctly movements in the direction of the
stock market or interest rates. There are several risks in connection with the
use of futures contracts by a Portfolio as a hedging devise. One risk arises
because of the imperfect correlation between movements in the price of the
futures contract and movements in the price of the securities which are the
subject of hedge. The price of the futures contract may move more than or less
than the price of the securities being hedged. If the price of the futures
contract moves less than the price of the securities which are the subject of
the hedge, the hedge will not be fully effective but, if the price of the
securities being hedged has moved in an unfavorable direction, a Portfolio would
be in a better position than if it had not hedged at all. If the price of the
securities being hedged has moved in a favorable direction, this advantage will
be partially offset by the loss on the futures contract. If the price of the
futures contract moves more than the price of the hedged securities, a Portfolio
involved will experience either a loss or gain on the futures contract which
will not be completely offset by movements in the price of the securities which
are the subject of the hedge.
It is also possible that, where a Portfolio has sold futures contracts
to hedge its portfolio against a decline in the market, the market may advance
and the value of securities held in a Portfolio may decline. If this occurred, a
Portfolio would lose money on the futures contract and also experience a decline
in value in its portfolio securities.
In addition to the possibility that there may be an imperfect
correlation, or no correlation at all, between movements in the futures contract
and the securities being
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hedged, the price of futures contracts may not correlate perfectly with movement
in the cash market due to certain market distortions. Due to the possibility of
price distortion in the futures market, and because of the imperfect correlation
between the movement in the cash market and movements in the price of futures
contracts, a correct forecast of general market trends or interest rate
movements by Bank of America may still not result in a successful hedging
transaction over a short time frame.
Positions in futures contracts may be closed out only on an exchange or
board of trade which provides a secondary market for such futures contracts.
Although the Portfolios intend to purchase or sell futures contracts 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. The liquidity of a secondary
market in a futures contract may in addition 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.
For additional information concerning Futures and options thereon,
please see Appendix B to this Statement of Additional Information.
Foreign Investments. The Portfolios corresponding to the Flexible Bond
and Asset Allocation Funds may invest in securities of foreign issuers that may
or may not be publicly traded in the United States.
Investments in foreign securities involve certain inherent risks, such
as political or economic instability of the issuer or the country of issue, the
difficulty of predicting international trade patterns and the possibility of
imposition of exchange controls. Such securities may also be subject to greater
fluctuations in price than securities of domestic corporations. In addition,
there may be less publicly available information about a foreign company than
about a domestic company. Foreign companies generally are not subject to uniform
accounting, auditing and financial reporting standards comparable to those
applicable to domestic companies. Foreign brokerage commissions and custodian
fees are generally higher than in the United States. With respect to certain
foreign countries, there
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is a possibility of expropriation or confiscatory taxation, or diplomatic
developments which could affect investment in those countries.
In considering whether to invest in the securities of a foreign
company, Bank of America considers such factors as the characteristics of the
particular company, differences between economic trends and the performance of
securities markets within the U.S. and those within other countries, and also
factors relating to the general economic, governmental and social conditions of
the country or countries where the company is located. The extent to which a
Portfolio will be invested in foreign companies will fluctuate from time to time
within the percentage limits stated above depending on the investment adviser's
assessment of prevailing market, economic and other conditions.
Municipal Securities. The Portfolios corresponding to the Flexible Bond
and Asset Allocation Funds may invest in Municipal Securities. Municipal
Securities are debt obligations issued to obtain funds for various public
purposes, including the construction of a wide range of public facilities, the
refunding of outstanding obligations, the payment of general operating expenses
and the extension of loans to public institutions and facilities. In addition,
certain types of private activity bonds (including industrial development bonds
under prior law) are issued by or on behalf of public authorities to finance
various privately-operated facilities. Such obligations are included within the
term Municipal Securities if the interest paid thereon is exempt from regular
Federal income tax.
The Portfolios corresponding to the Flexible Bond and Asset Allocation
Funds may purchase short-term Tax Anticipation Notes, Bond Anticipation Notes,
Revenue Anticipation Notes and other forms of short-term tax-exempt loans. Such
notes are issued with a short-term maturity in anticipation of the receipt of
tax funds, the proceeds of bond placements or other revenues. The Portfolios may
also purchase tax-exempt commercial paper.
There are, of course, variations in the quality of Municipal
Securities, both within a particular classification and between classifications,
and the yields on Municipal Securities depend upon a variety of factors,
including general money market conditions, the financial condition of the
issuer, general conditions of the municipal bond market, the size of a
particular offering, the maturity of the obligation and the rating of the issue.
The ratings of Moody's, S&P, Fitch and D&P represent their opinions as to the
quality of Municipal Securities. It should be emphasized, however, that ratings
are general and are not absolute standards of quality, and Municipal Securities
with
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the same maturity, interest rate and rating may have different yields while
Municipal Securities of the same maturity and interest rate with different
ratings may have the same yield. Subsequent to its purchase by a Portfolio, an
issue of Municipal Securities may cease to be rated or its rating may be
reduced. The investment adviser will consider such an event in determining
whether the Portfolio should continue to hold the obligation.
An issuer's obligations under its Municipal Securities are subject to
the provisions of bankruptcy, insolvency and other laws affecting the rights and
remedies of creditors, such as the federal Bankruptcy Code, and laws, if any,
which may be enacted by federal or state legislatures extending the time for
payment of principal or interest, or both, or imposing other constraints upon
enforcement of such obligations. The power or ability of an issuer to meet its
obligations for the payment of interest on, and principal of, its Municipal
Securities may be materially adversely affected by litigation or other
conditions. Further, it should also be noted with respect to all Municipal
Securities issued after August 15, 1986 (August 31, 1986 in the case of certain
bonds), the issuer must comply with certain rules formerly applicable only to
"industrial development bonds" which, if the issuer fails to observe them, could
cause interest on the Municipal Securities to become taxable retroactive to the
date of issue.
Information about the financial condition of issuers of Municipal
Securities may be less available than about corporations a class of whose
securities is registered under the Securities Exchange Act of 1934.
When-Issued Securities and Forward Commitments. The Portfolios may
purchase securities on a "when-issued" basis and may purchase or sell securities
on a "forward commitment" basis. When a Portfolio agrees to purchase securities
on a "when-issued," or forward commitment basis, its custodian will set aside
cash or liquid portfolio securities equal to the amount of the commitment in a
separate account. Normally, the custodian will set aside portfolio securities to
satisfy a purchase commitment. In such a case, a Portfolio may be required
subsequently to place additional assets in the separate account in order to
assure that the value of the account remains equal to the amount of the
commitment. It may be expected that the net assets of a Portfolio (and the
corresponding Fund) will fluctuate to a greater degree when it sets aside
portfolio securities to cover such purchase commitments than when it sets aside
cash. The Portfolios do not intend to engage in these transactions for
speculative purposes but only in furtherance of their investment objectives.
Because a Portfolio will set aside cash or liquid portfolio securities to
satisfy its purchase commitments in the
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manner described, its liquidity and the ability of the investment adviser to
manage it may be affected in the event the forward commitments and commitments
to purchase when-issued securities ever exceeded 25% of the value of a
Portfolio's assets.
A Portfolio will purchase securities on a when-issued or forward
commitment basis only with the intention of completing the transaction. If
deemed advisable as a matter of investment strategy, however, a Portfolio may
dispose of or renegotiate a commitment after it is entered into, and may sell
securities it has committed to purchase before those securities are delivered to
the Portfolio on the settlement date. In these cases the Portfolio may realize a
taxable capital gain or loss.
When a Portfolio engages in when-issued and forward commitment
transactions, it relies on the other party to consummate the trade. Failure of
such party to do so may result in the Portfolio's incurring a loss or missing an
opportunity to obtain a price considered to be advantageous.
The market value of the securities underlying a when-issued purchase
or forward commitment transaction and any subsequent fluctuations in their
market value is taken into account when determining the market value of a
Portfolio starting on the day the Portfolio agrees to purchase the securities. A
Portfolio does not earn interest on the securities it has committed to purchase
until they are paid for and delivered on the settlement date.
OTHER INVESTMENT LIMITATIONS
The Prospectus for each Fund sets forth or summarizes certain
fundamental policies that may not be changed with respect to such Fund or its
corresponding Portfolio without the affirmative vote of the holders of the
majority of the Fund's outstanding shares or the Portfolio's outstanding
interests (as defined below under "General Information - Miscellaneous"). The
following is a complete list of fundamental policies which may not be changed
for any Fund or Portfolio without such a vote of shareholders or
interestholders.
NEITHER THE FLEXIBLE BOND, BLUE CHIP OR ASSET ALLOCATION FUNDS, NOR
THEIR CORRESPONDING PORTFOLIOS, MAY:
1. Purchase securities (except securities issued by the U.S.
Government, its agencies or instrumentalities) if, as a
result, more than 5% of its total assets will be invested in
the securities of any one issuer or it would own more than 10%
of the voting securities of such issuer,
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except that up to 25% of its total assets may be invested
without regard to these limitations; and provided that all of
its assets may be invested in a diversified, open-end
management investment company, or a series thereof, with
substantially the same investment objectives, policies and
restrictions without regard to the limitations set forth in
this paragraph;
2. Pledge, mortgage or hypothecate the assets of any Fund to any
extent greater than 10% of the value of the total assets of
that Fund.
3. Make loans to other persons, except that a Fund may make time
or demand deposits with banks, provided that time deposits
shall not have an aggregate value in excess of 10% of a Fund's
net assets, and may purchase bonds, debentures or similar
obligations that are publicly distributed, may loan portfolio
securities not in excess of 10% of the value of the total
assets of such Fund, and may enter into repurchase agreements
as long as repurchase agreements maturing in more than seven
days do not exceed 10% of the value of the total assets of a
Fund;
4. Purchase or sell commodities contracts, except that any Fund
may purchase or sell futures contracts on financial
instruments, such as bank certificates of deposit and U.S.
Government securities, foreign currencies and stock indexes
and options on any such futures if such options are written by
other persons and if (i) the futures or options are listed on
a national securities or commodities exchange, (ii) the
aggregate premiums paid on all such options that are held at
any time do not exceed 20% of the total net assets of that
Fund, and (iii) the aggregate margin deposits required on all
such futures or options thereon held at any time do not exceed
5% of the total assets of the Fund;
5. Purchase any securities for any Fund that would cause more
than 25% of the value of the Fund's total assets at the time
of such purchase to be invested in the securities of one or
more issuers conducting their principal activities in the same
industry; provided that there is no limitation with respect to
investments in obligations issued or guaranteed by the United
States Government, its
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<PAGE> 149
agencies and instrumentalities; and provided further that a
Fund may invest all its assets in a diversified, open-end
management investment company, or a series thereof, with
substantially the same investment objectives, policies and
restrictions as the Fund without regard to the limitations set
forth in this paragraph (2).
6. Invest the assets of any Fund in nonmarketable securities that
are not readily marketable (including repurchase agreements
maturing in more than seven days, securities described in
restriction (2) in the Prospectus, restricted securities,
certain OTC options and securities used as cover for such
options and stripped mortgage-backed securities) to any extent
greater than 10% of the value of the total assets of that
Fund; provided, however, that a Fund may invest all its assets
in a diversified, open-end management investment company, or a
series thereof with substantially the same investment
objectives, policies and restrictions as the Fund, without
regard to the limitations set forth in this paragraph (3).
7. Borrow money for any Fund except for temporary emergency
purposes and then only in an amount not exceeding 5% of the
value of the total assets of that Fund. Borrowing shall, for
purposes of this paragraph, include reverse repurchase
agreements. Any borrowings, other than reverse repurchase
agreements, will be from banks. The Company will repay all
borrowings in any Fund before making additional investments
for that Fund and interest paid on such borrowings will reduce
income.
8. Issue senior securities.
9. Underwrite any issue of securities, provided, however, that a
Fund may invest all its assets in a diversified, open-end
management investment company, or a series thereof, having
substantially the same investment objectives, policies and
restrictions as such Fund, without regard to the limitations
set forth in this paragraph (6).
10. Purchase or sell real estate or real estate mortgage loans,
but this shall not prevent investments in instruments secured
by real estate
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<PAGE> 150
or interests therein or in marketable securities of issuers
that engage in real estate operations.
11. Purchase on margin or sell short.
12. Purchase or retain securities of an issuer if those members of
the Board of the Company or the Portfolio, each of whom own
more than 1/2 of 1% of such securities, together own more than
5% of the securities of such issuer, provided, however, that a
Fund may invest all its assets in a diversified, open-end
management investment company, or a series thereof, having
substantially the same investment objectives, policies and
restrictions as such Fund, without regard to the limitations
set forth in this paragraph (9).
13. Purchase securities of any other investment company (except in
connection with a merger, consolidation, acquisition or
reorganization) if, immediately after such purchase, the
Company (and any companies controlled by it) would own in the
aggregate (i) more than 3% of the total outstanding voting
stock of such investment company, (ii) securities issued by
such investment company would have an aggregate value in
excess of 5% of the value of the total assets of the Company,
or (iii) securities issued by such investment company and all
other investment companies would have an aggregate value in
excess of 10% of the value of the total assets of the Company
provided, however, that a Fund may invest all its assets in a
diversified, open-end management investment company, or a
series thereof, having substantially the same investment
objectives, policies and restrictions as such Fund, without
regard to the limitations set forth in this paragraph (10).
14. Invest in or sell put, call, straddle or spread options or
interests in oil, gas or other mineral exploration or
development programs.
* * *
If a percentage restriction is satisfied at the time of investment, a
later increase or decrease in such percentage resulting from a change in asset
value will not constitute a violation of such restriction.
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<PAGE> 151
The Funds and Portfolios treat, in accordance with the current views of
the Staff of the SEC and as a matter of non-fundamental policy that may be
changed without a vote of shareholders or interestholders, all supranational
organizations as a single industry and each foreign government (and all of its
agencies) as a separate industry.
In order to permit the sale of a Fund's shares in certain states, the
Company or Master Investment Trust, Series I (the "Master Trust") may make
commitments more restrictive than the investment policies and limitations
described above. As of the date of this Statement of Additional Information, the
following such commitments have been made:
1. The Portfolios will not invest more than 5% of the value of
their net assets in warrants, of which no more than 2% may be
warrants which are not listed on the New York or American
Stock Exchanges.
2. The Portfolios will not invest in oil, gas or other mineral
leases.
3. The Portfolios will not purchase or sell real property,
including limited partnership interests, but excluding readily
marketable interests in Real Estate Investment Trusts
("REITs") or readily marketable securities of companies that
invest in real estate in real estate limited partnerships.
4. The Portfolios have agreed to exclude any assets of a
Portfolio which are invested in the shares of any money market
mutual fund for the purposes of calculating that Portfolio's
investment advisory fee.
In the event that the Company or the Master Trust determines that any
such commitment is no longer in the best interests of a Portfolio, it may revoke
its commitment. In such event, the corresponding Fund may no longer be able to
sell its securities in such state.
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION
Information on how to purchase and redeem Fund shares, and how such
shares are priced, is included in the Prospectuses. The net asset values of the
Portfolios corresponding to the Flexible Bond, Blue Chip and Asset Allocation
Funds are determined at the same time and on the same days as the net asset
values per share of these respective Funds are determined. The
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<PAGE> 152
net asset value of each of these three Funds is equal to the Fund's pro rata
share of the total investments and other assets of its corresponding Portfolio,
less any liabilities with respect to such Fund, including each Fund's pro rata
share of the Portfolio's liabilities. Additional information is contained below.
VALUATION OF THE CORRESPONDING PORTFOLIOS FOR THE FLEXIBLE BOND,
BLUE CHIP AND ASSET ALLOCATION FUNDS
Except for debt securities held by the Portfolios with remaining
maturities of 60 days or less, assets for which market quotations are available
are valued as follows: (a) each listed security is valued at its closing price
obtained from the primary exchange on which the security is listed, or, if there
were no sales on that day, at its last reported current closing price; (b) each
unlisted security is valued at the last current bid price (or last current sale
price, as applicable) obtained from the NASDAQ; (c) United States Government and
agency obligations are valued based upon bid quotations from the Federal Reserve
Bank for identical or similar obligations; and (d) short-term money market
instruments (such as certificates of deposit, bankers' acceptances and
commercial paper) are most often valued by bid quotations or by reference to bid
quotations of available yields for similar instruments of issuers with similar
credit ratings. The Board of Trustees of the Master Trust has determined that
the values obtained using the procedures described in (c) and (d) represent the
fair values of the securities valued by such procedures. Most of these prices
are obtained by PFPC, Inc. ("PFPC") from a service that collects and
disseminates such market prices. Bid quotations for short-term money market
instruments reported by such service are the bid quotations reported to it by
major dealers in such instruments.
Valuation of options is described above under "Investment Objectives
and Policies--Options Trading."
Debt securities held by the Portfolios with remaining maturities of 60
days or less are valued on the basis of amortized cost, which provides stability
of net asset value. Under this method of valuation, the security is initially
valued at cost on the date of purchase or, in the case of securities purchased
with more than 60 days remaining to maturity and to be valued on the amortized
cost basis only during the final 60 days of its maturity, the market value on
the 61st day prior to maturity. Thereafter the Master Trust assumes a constant
proportionate amortization in value until maturity of any discount or premium,
regardless of the impact of fluctuating interest rates on the market value of
the security, unless the Board of Trustees determines that amortized cost no
longer
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<PAGE> 153
represents fair value. The Master Trust will monitor the market value of these
investments for the purpose of ascertaining whether any such circumstances
exist.
When approved by the Board of Trustees of the Master Trust, certain
securities may be valued on the basis of valuations provided by an independent
pricing service when such prices are believed to reflect the fair market value
of such securities. These securities may include those that have no available
recent market value, have few outstanding shares and therefore infrequent
trades, or for which there is a lack of consensus on the value, with quoted
prices covering a wide range. The lack of consensus might result from relatively
unusual circumstances such as no trading in the security for long periods of
time, or a company's involvement in merger or acquisition activity, with widely
varying valuations placed on the company's assets or stock. Prices provided by
an independent pricing service may be determined without exclusive reliance on
quoted prices and may take into account appropriate factors such as
institutional-size trading in similar groups of securities, yield, quality,
coupon rate, maturity, type of issue, trading characteristics and other market
data.
In the absence of an ascertainable market value, assets are valued at
their fair value as determined using methods and procedures reviewed and
approved by the Board of Trustees of the Master Trust.
SUPPLEMENTARY PURCHASE INFORMATION
For the purpose of applying the Right of Accumulation or Letter of
Intent privileges described in the Prospectuses, the scale of sales loads
applies to purchases made by any "purchaser," which term includes an individual
and/or spouse purchasing securities for his, her or their own account or for the
account of any minor children; or a trustee or other fiduciary account
(including a pension, profit-sharing or other employee benefit trust created
pursuant to a plan qualified under Section 401 of the Internal Revenue Code)
although more than one beneficiary is involved; or "a qualified group" which has
been in existence for more than six months and has not been organized for the
purpose of buying redeemable securities of a registered investment company at a
discount, provided that the purchases are made through a central administrator
or a single dealer, or by other means which result in economy of sales effort or
expense. A "qualified group" must have more than 10 members, must be available
to arrange for group meetings between representatives of the Funds and the
members, and must be able to arrange for mailings to members at reduced or no
cost to the Distributor.
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<PAGE> 154
The value of shares eligible for the Right of Accumulation privilege may also be
used as a credit toward completion of the Letter of Intent privilege. Such
shares will be valued at their offering price prevailing on the date of
submission of the Letter of Intent. Distributions on shares held in escrow
pursuant to the Letter of Intent privilege will be credited to the shareholder,
but such shares are not eligible for a Fund's Exchange Privilege.
The computation of the hypothetical offering price per share of each
Fund based on the value of each Fund's net assets on February 28, 1995 and each
Fund's outstanding securities on such date is as follows:
<TABLE>
<CAPTION>
Flexible Bond Blue Chip Asset Allocation
Fund Fund Fund
------------- ---------- ----------------
<S> <C> <C> <C>
Net Assets $1,964,102 $6,001,990 $5,693,645
Outstanding Securities 208,132 379,730 375,911
Net Asset Value Per Share
Sales Charge, 4.50 $ 9.44 $ 15.81 $ 15.15
percent of offering price
(4.71 percent of net
asset value per share) $ 0.44 $ 0.74 $ 0.71
Offering Price to Public $ 9.88 $ 16.55 $ 15.86
</TABLE>
SUPPLEMENTARY REDEMPTION INFORMATION: ALL FUNDS
Shares in the Funds for which orders for wire redemption are received
on a business day before the close of regular trading hours on the New York
Stock Exchange (currently 4:00 p.m. Eastern Time) will be redeemed as of the
close of regular trading hours on such Exchange and the proceeds of redemption
(less any applicable contingent deferred sales charge imposed on shareholders
who purchased shares of a Fund of $1 million or more without a front-end sales
load and redeem such shares within 2 years after purchase) will normally be
wired in federal funds on the next business day to the commercial bank
specified by the investor on the Account Application (or other bank of
record on the investor's file with the Transfer Agent). To qualify to
use the wire redemption privilege, the payment for Fund shares must be drawn
on, and redemption proceeds paid to, the same bank and account as designated
on the Account Application (or other bank of record as described above). If the
proceeds of a particular redemption are to be wired to another bank, the
request must be in writing and signature guaranteed. Shares for which orders
for wire redemption are received after the close of regular trading hours on
the New York Stock Exchange
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<PAGE> 155
or on a non-business day will be redeemed as of the close of trading on
such Exchange on the next day on which shares of the particular Fund are priced
and the proceeds (less any applicable contingent deferred sales charge imposed
on shareholders who purchased shares of a Fund of $1 million or more without a
front-end sales load and redeem such shares within 2 years after purchase)
will normally be wired in federal funds on the next business day thereafter.
Redemption proceeds (less any applicable contingent deferred sales charge
imposed on shareholders who purchased shares of a Fund of $1 million or more
without a front-end sales load and redeem such shares within 2 years after
purchase) will be wired to a correspondent member bank if the investor's
designated bank is not a member of the Federal Reserve System. Immediate
notification by the correspondent bank to the investor's bank is necessary to
avoid a delay in crediting the funds to the investor's bank account. Proceeds
of less than $1,000 will be mailed to the investor's address.
To change the commercial bank or account designated to receive
redemption proceeds, a written request must be sent to the Company, c/o Pacific
Horizon Funds, Inc., P.O. Box 80221, Los Angeles, California 90080-9909. Such
request must be signed by each shareholder, with each signature guaranteed as
described in the Funds' Prospectuses. Guarantees must be signed by an authorized
signatory and "signature guaranteed" must appear with the signature. The
Transfer Agent may request further documentation from corporations, executors,
administrators, trustees or guardians, and will accept other suitable
verification arrangements from foreign investors, such as consular verification.
SUPPLEMENTARY PURCHASE INFORMATION: ALL FUNDS
In General. As described in the Prospectuses, Fund shares may be
purchased directly by the public, by clients of Bank of America through their
qualified trust and agency accounts, or by clients of securities dealers,
financial institutions (including banks) and other industry professionals, such
as investment advisers, accountants and estate planning firms that have entered
into service and/or selling agreements with the Distributor. (The Distributor,
such institutions and professionals are collectively referred to as "Service
Organizations.") Bank of America and Service Organizations may impose minimum
customer account and other requirements in addition to those imposed by the Fund
and described in the respective Prospectuses. Purchase orders will be effected
only on business days.
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<PAGE> 156
Shares in each Fund are sold with a sales load. However, there is no
front-end sales load on combined purchases of shares of $1 million or more.
Concord Financial Group, Inc. will pay commissions of up to 1.00% to brokers
whose customers purchase such shares. Additionally, a 1.00% and 0.50%
contingent deferred sales charge is applicable to shareholders who purchase
shares of a Fund of $1 million or more without a front-end sales load and
redeem such shares within one year and two years, respectively, after purchase.
Service Organizations may be paid by the Distributor at the Company's expense
for shareholder services. Depending on the terms of the particular account,
Bank of America, its affiliates, and Service Organizations also may charge
their customers fees for automatic investment, redemption and other services
provided. Such fees may include, for example, account maintenance fees,
compensating balance requirements or fees based upon account transactions,
assets or income. Bank of America or the particular Service Organization is
responsible for providing information concerning these services and any
charges to any customer who must authorize the purchase of Fund shares prior
to such purchase.
Persons wishing to purchase Company shares through their accounts at
Bank of America or a Service Organization should contact such entity directly
for appropriate instructions.
Initial purchases of shares into a new account may not be made by wire.
However, persons wishing to make a subsequent purchase of Company shares into an
already existing account by wire should telephone the Transfer Agent at (800)
346-2087. The investor's bank must be instructed to wire federal funds to the
Transfer Agent, referring in the wire to the particular Fund in which such
investment is to be made; the investor's portfolio account number; and the
investor's name.
The Transfer Agent may charge a fee to act as Custodian for IRAs,
payment of which could require the liquidation of shares. All fees charged are
described in the appropriate form. Shares may be purchased in connection with
these plans only by direct remittance to the Transfer Agent. Purchases for IRA
accounts will be effective only when payments received by the Transfer Agent are
converted into federal funds. Purchases for these plans may not be made in
advance of receipt of funds.
For processing redemptions, the Transfer Agent may request further
documentation from corporations, executors, administrators, trustees or
guardians. The Transfer Agent will accept other suitable verification
arrangements from foreign investors, such as consular verification.
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<PAGE> 157
Investors should be aware that if they have selected the TeleTrade
Privilege, any request for a wire redemption will be effected as a TeleTrade
transaction through the Automated Clearing House (ACH) system unless more prompt
transmittal is specifically requested. Redemption proceeds of a TeleTrade
transaction will be on deposit in the investor's account at the ACH member bank
normally two business days after receipt of the redemption request.
Exchange Privilege. Shareholders in the Pacific Horizon Family of Funds
have an exchange privilege whereby they may exchange all or part of their
Pacific Horizon Shares for shares of other investment portfolios in the Pacific
Horizon Family of Funds. Shareholders may also exchange all or a part of their
Pacific Horizon Shares for like shares of an investment portfolio of Time
Horizon Funds. By use of the exchange privilege, the investor authorizes the
Transfer Agent to act on telephonic, telegraphic or written exchange
instructions from any person representing himself or herself to be the investor
and believed by the Transfer Agent to be genuine. The Transfer Agent's records
of such instructions are binding. The exchange privilege may be modified or
terminated at any time upon notice to shareholders. For federal income tax
purposes, exchange transactions are treated as sales on which a purchaser will
realize a capital gain or loss depending on whether the value of the shares
exchanged is more or less than his basis in such shares at the time of the
transaction.
Exchange transactions described in Paragraphs A, B, C and D below will
be made on the basis of the relative net asset values per share of the
investment portfolios involved in the transaction.
A. Shares of any investment portfolio purchased with a sales load, as well
as additional shares acquired through reinvestment of dividends or
distributions on such shares, may be exchanged without a sales load for
shares of any other investment portfolio in the Pacific Horizon Family
of Funds or Time Horizon Funds.
B. Shares of any investment portfolio in the Pacific Horizon Family of
Funds or Time Horizon Funds acquired by a previous exchange transaction
involving shares on which a sales load has directly or indirectly been
paid (e.g. shares purchased with a sales load or issued in connection
with an exchange transaction involving shares that had been purchased
with a sales load), as well as additional shares acquired through
reinvestment of dividends or distributions on such shares, may be
redeemed and the proceeds used to purchase without a
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<PAGE> 158
sales load shares of any other investment portfolio. To accomplish an
exchange transaction under the provisions of this Paragraph, investors
must notify the Transfer Agent of their prior ownership of shares and
their account number.
C. Shares of any investment portfolio in the Pacific Horizon Family of
Funds may be exchanged without a sales load for shares of any other
investment portfolio in the Family that is offered without a sales
load.
D. Shares of any investment portfolio in the Pacific Horizon Family of
Funds purchased without a sales load may be exchanged without a sales
load for shares in any other portfolio where the investor involved
maintained an account in the Pacific Horizon Family of Funds before
April 20, 1987 or was the beneficial owner of shares of Bunker Hill
Income Securities, Inc. on the date of its reorganization into the
Pacific Horizon Corporate Bond Fund.
Neither a contingent deferred sales charge nor a front-end sales load
will be imposed at the time of exchange if a shareholder purchases shares of a
Fund of $1 million or more without a front-end sales load and exhanges such
shares for shares of another investment portfolio of the Company or Time
Horizon Funds. However, shares acquired in the exchange are subject to a
contingent deferred sales charge of 1.00% and 0.50%, respectively, on
redemptions within one year and two years after purchase.
Except as stated above, a sales load will be imposed when shares of any
investment portfolio in the Pacific Horizon Family of Funds that were purchased
or otherwise acquired without a sales load are exchanged for shares of another
investment portfolio in the Pacific Horizon Family or Time Horizon Funds which
are sold with a sales load.
Exchange requests received on a business day prior to the time shares
of the investment portfolios involved in the request are priced will be
processed on the date of receipt. "Processing" a request means that shares in
the investment portfolio from which the shareholder is withdrawing an investment
will be redeemed at the net asset value per share next determined on the date of
receipt. Shares of the new investment portfolio into which the shareholder is
investing will also normally be purchased at the net asset value per share next
determined coincident to or after the time of redemption. Exchange requests
received on a business day after the time shares of the investment portfolios
involved in the request are priced will be processed on the next business day in
the manner described above.
Miscellaneous. Certificates for shares will not be issued.
Depending on the terms of the customer account at Bank of America or a
Service Organization, certain purchasers may arrange with the Company's
custodian for sub-accounting services paid by the Company without direct charge
to the purchaser.
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<PAGE> 159
A "business day" for purposes of processing share purchases and
redemptions received by the Transfer Agent at its Columbus office is a day on
which the New York Stock Exchange is open for trading. In 1996, the holidays on
which the New York Stock Exchange is closed are: New Year's Day, Presidents'
Day, Good Friday, Memorial Day (observed), Independence Day, Labor Day,
Thanksgiving Day and Christmas Day.
The Company may suspend the right of redemption or postpone the date of
payment for shares during any period when (a) trading on the New York Stock
Exchange is restricted by applicable rules and regulations of the SEC; (b) the
New York Stock Exchange is closed for other than customary weekend and holiday
closings; (c) the SEC has by order permitted such suspension; or (d) an
emergency exists as determined by the SEC. (The Company may also suspend or
postpone the recordation of the transfer of its shares upon the occurrence of
any of the foregoing conditions.)
The Company's Charter permits its Board of Directors to require a
shareholder to redeem involuntarily shares in a Fund if the balance held of
record by the shareholder drops below $500 and such shareholder does not
increase such balance to $500 or more upon 60 days' notice. The Company will not
require a shareholder to redeem shares of a Fund if the balance held of record
by the shareholder is less than $500 solely because of a decline in the net
asset value of the Fund's shares. The Company may also redeem shares
involuntarily if such redemption is appropriate to carry out the Company's
responsibilities under the 1940 Act.
If the Company's Board of Directors determines that conditions exist
which make payment of redemption proceeds wholly in cash unwise or undesirable,
the Company may make payment wholly or partly in securities or other property.
Additionally, the Company has made an undertaking to the State of Texas that it
may only make payment of such proceeds wholly or in part in "readily marketable"
securities or other property. (If the Company determines that such undertaking
is no longer in its best interests, it will revoke such commitment. In such an
event, the Fund will no longer be able to sell its shares in the State of
Texas.) In such an event, a shareholder would incur transaction costs in selling
the securities or other property. The Company has committed that it will pay all
redemption requests by a shareholder of record in cash, limited in amount with
respect to each shareholder during any ninety-day period to the lesser of
$250,000 or 1% of the net asset value at the beginning of such period.
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<PAGE> 160
ADDITIONAL INFORMATION CONCERNING TAXES
FEDERAL - ALL FUNDS
Each Fund will be treated as a separate corporate entity under the
Internal Revenue Code of 1986, as amended (the "Code"), and intends to qualify
as a "regulated investment company." By following this policy, each Fund expects
to eliminate or reduce to a nominal amount the federal income taxes to which it
may be subject. If for any taxable year a Fund of the Company does not qualify
for the special federal tax treatment afforded regulated investment companies,
all of the Fund's taxable income would be subject to tax at regular corporate
rates (without any deduction for distributions to shareholders). In such event,
the Fund's dividend distributions to shareholders would be taxable as ordinary
income to the extent of the current and accumulated earnings and profits of the
particular Fund and would be eligible for the dividends received deduction in
the case of corporate shareholders.
Qualification as a regulated investment company under the Code
requires, among other things, that each Fund distribute to its shareholders an
amount equal to at least the sum of 90% of its investment company taxable income
(if any) and 90% of its tax-exempt income (if any), net of certain deductions
for each taxable year. In general, a Fund's investment company taxable income
will be its taxable income, including dividends, interest, and short-term
capital gains (the excess of net short-term capital gain over net long-term
capital loss), subject to certain adjustments and excluding the excess of any
net long-term capital gain for the taxable year over the net short-term capital
loss, if any, for such year. A Fund will be taxed on its undistributed
investment company taxable income, if any. As stated, each Fund of the Company
intends to distribute at least 90% of its investment company taxable income (if
any) for each taxable year. To the extent such income is distributed by a Fund
(whether in cash or additional shares) it will be taxable to shareholders as
ordinary income.
A Fund will not be treated as a regulated investment company under the
Code if 30% or more of the Fund's gross income for a taxable year is derived
from gains realized on the sale or other disposition of the following
investments held for less than three months (the "Short-Short test"): (1) stock
and securities (as defined in section 2(a)(36) of the 1940 Act); (2) options,
futures and forward contracts other than those on foreign currencies; and (3)
foreign currencies (and options, futures and forward contracts on foreign
currencies) that are not directly related to a Fund's principal business of
investing in stock and securities (and options and futures with respect to
stocks and
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<PAGE> 161
securities). Interest (including original issue discount and accrued market
discount) received by a Fund upon maturity or disposition of a security held for
less than three months will not be treated as gross income derived from the sale
or other disposition of such security within the meaning of this requirement.
However, any other income that is attributable to realized market appreciation
will be treated as gross income from the sale or other disposition of securities
for this purpose. With respect to covered call options, if the call is exercised
by the holder, the premium and the price received on exercise constitute the
proceeds of sale, and the difference between the proceeds and the cost of the
securities subject to the call is capital gain or loss. Premiums from expired
call options written by a Fund and net gains from closing purchase transactions
are treated as short-term capital gains for federal income tax purposes, and
losses on closing purchase transactions are short-term capital losses. See
Appendix B -- "Accounting and Tax Treatment" for a general discussion of the
federal tax treatment of futures contracts, related options thereon and other
financial instruments, including their treatment under the Short-Short test.
Any distribution of the excess of net long-term capital gains over net
short-term capital losses is taxable to shareholders as long-term capital gains,
regardless of how long the shareholder has held the distributing Fund's shares
and whether such gains are received in cash or additional Fund shares. The Fund
will designate such a distribution as a capital gain dividend in a written
notice mailed to shareholders after the close of the Fund's taxable year. It
should be noted that, upon the sale or exchange of Fund shares, if the
shareholder has not held such shares for longer than six months, any loss on the
sale or exchange of those shares will be treated as long-term capital loss to
the extent of the capital gain dividends received with respect to the shares.
Ordinary income of individuals is taxable at a maximum nominal rate of
39.6%, but because of limitations on itemized deductions otherwise allowable and
the phase-out of personal exemptions, the maximum effective marginal rate of tax
for some taxpayers may be higher. An individual's long-term capital gains are
taxable at a maximum nominal rate of 28%. For corporations, long-term capital
gains and ordinary income are both taxable at a maximum nominal rate of 35% (an
effective marginal rate of 39% applies in the case of corporations having
taxable income between $100,000 and $335,000).
A 4% non-deductible excise tax is imposed on regulated investment
companies that fail currently to distribute specific percentages of their
ordinary taxable income and capital gain net
- 31 -
<PAGE> 162
income (excess of capital gains over capital losses). Each Fund intends to make
sufficient distributions or deemed distributions of its ordinary taxable income
and any capital gain net income prior to the end of each calendar year to avoid
liability for this excise tax.
The Company 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 upon sale paid to shareholders (i) who have failed to provide either a
correct tax identification number in the manner provided, (ii) who are subject
to withholding by the Internal Revenue Service for failure to properly include
on their return payments of taxable interest or dividends, or (iii) who have
failed to certify to the Company either that they are subject to backup
withholding when required to do so or that they are "exempt recipients."
TAXATION OF THE PORTFOLIOS
Management of the Portfolios corresponding to the Flexible Bond, Blue
Chip and Asset Allocation Funds intends for each Portfolio to be treated as a
partnership rather than as a regulated investment company or a corporation under
the Code. As partnerships under the Code, any interest, dividends, gains and
losses of the Portfolios will be deemed to have been "passed through" to their
investors regardless whether any amounts are actually distributed by the
Portfolios.
Each investor in a Portfolio will be taxable on its share (as
determined in accordance with the governing instruments of the Portfolio) of the
Portfolio's ordinary income and capital gains in determining its income tax
liability. The determination of such share will be made in accordance with the
Code and regulations promulgated thereunder. It is intended that each
Portfolio's assets, income and distributions will be managed in such a way that
an investor in a Portfolio will be able to satisfy the requirements of
Subchapter M of the Code, assuming that the investor invested all of its assets
in the Portfolio.
OTHER INFORMATION
Depending upon the extent of 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, the
Funds may be subject to the tax laws of such states or localities.
- 32 -
<PAGE> 163
Shareholders are advised to consult their tax advisers because state
and local tax consequences may be different from the federal tax consequences
described above.
The foregoing discussion is based on tax laws and regulations which are
in effect on the date of this Statement of Additional Information. Such laws and
regulations may be changed by legislative or administrative action. This
discussion is only a summary of some of the important tax considerations
generally affecting purchasers of Fund shares. No attempt is made to present a
detailed explanation of the federal income tax treatment of the Funds or their
shareholders, and this discussion is not intended as a substitute for careful
tax planning. Accordingly, potential purchasers of Fund shares should consult
their tax advisers with specific reference to their own tax situation.
MANAGEMENT
DIRECTORS AND OFFICERS OF THE COMPANY
The directors and officers of the Company, their addresses, ages and
principal occupations during the past five years are:
<TABLE>
<CAPTION>
Position with
-------------
Name and Address Age Company Principal Occupations
- ---------------- --- ------- ---------------------
<S> <C> <C> <C>
Thomas M. Collins 61 Director Of counsel, law firm of
McDermott & Trayner McDermott & Trayner;
225 S. Lake Avenue Partner of the law firm
Suite 410 of Musick, Peeler &
Pasadena, CA 91101-3005 Garrett (until April,
1993); Trustee, Master
Investment Trust Series I and
Master Investment Trust,
Series II (registered
investment companies) (since
1993); former Director, Bunker
Hill Income Securities, Inc.
(registered investment
company) through 1991.
</TABLE>
- 33 -
<PAGE> 164
<TABLE>
<CAPTION>
Position with
-------------
Name and Address Age Company Principal Occupations
- ---------------- --- ------- ---------------------
<S> <C> <C> <C>
Douglas B. Fletcher 70 Vice Chairman Chairman of the Board
Fletcher Capital of the Board and Chief Executive
Advisors Incorporated Officer, Fletcher
4 Upper Newport Plaza Capital Advisors,
Suite 100 Incorporated,
Newport Beach, CA 92660-2629 (registered
investment adviser) 1991
to date; Partner, 1991
Newport Partners (private
venture capital firm),
1981 to date; Chairman of
the Board and Chief
Executive Officer, First
Pacific Advisors, Inc.
(registered investment
adviser) and seven
investment companies
under its management,
prior to 1983; former
Allied Member, New York
Stock Exchange; Chairman
of the Board of FPA
Paramount Fund, Inc.
through 1984; Director,
TIS Mortgage Investment
Company (real estate
investment trust);
Trustee and former Vice
Chairman of the Board,
Claremont McKenna
College; Chartered
Financial Analyst.
Robert E. Greeley 62 Director Chairman, Page Mill
Page Mill Asset Asset Management (a
Management private investment
433 California Street company) since 1991;
Suite 900 Manager, Corporate
San Francisco, CA 94104 Investments, Hewlett
Packard Company from 1979
to 1991; Trustee, Master
Investment Trust, Series
I and Master Investment
Trust, Series II (since
1993); Director, Morgan
Grenfell Small Cap Fund
(since 1986); former
Director, Bunker Hill
Income Securities, Inc.
(since 1989) (registered
investment companies);
former Trustee,
</TABLE>
- 34 -
<PAGE> 165
<TABLE>
<CAPTION>
Position with
-------------
Name and Address Age Company Principal Occupations
- ---------------- --- ------- ---------------------
<S> <C> <C> <C>
SunAmerica Fund Group
(previously Equitec
Siebel Fund Group) from
1984 to 1992.
Kermit O. Hanson 79 Director Vice Chairman of the
17760 14th Ave., N.W. Advisory Board, 1988 to
Seattle, WA 98177 date, Executive
Director, 1977 to 1988,
Pacific Rim Bankers
Program (a non-profit
educational institution);
Dean Emeritus, 1981 to
date, Dean, 1964-81,
Graduate School of
Business Administration,
University of Washington;
Director, Washington
Federal Savings & Loan
Association; Trustee,
Seafirst Retirement Funds
(since 1993) (registered
investment company).
Cornelius J. Pings* 66 Chairman of President, Association
Association of American the Board and of American
Universities President Universities, February
One DuPont Circle 1993 to date; Provost,
Suite 730 1982 to January
Washington, DC 20036 1993, Senior Vice
President for Academic
Affairs, 1981 to January
1993, University of
Southern California;
Trustee, Master
Investment Trust, Series
I and Master Investment
Trust, Series II (since
1995).
Kenneth L. Trefftzs 83 Director Private Investor;
11131 Briarcliff Drive formerly Distinguished
San Diego, CA 92131-1329 Emeritus Professor
of Finance and Chairman
of the Department of
Finance and Business
Economics of the
Graduate School of
Business of the
University of Southern
California; former
</TABLE>
- 35 -
<PAGE> 166
<TABLE>
<CAPTION>
Position with
-------------
Name and Address Age Company Principal Occupations
- ---------------- --- ------- ---------------------
<S> <C> <C> <C>
Director, Metro Goldwyn
Mayer, Inc.; Director,
Fremont General
Corporation (insurance
and financial services
holding company);
Director, Source Capital,
Inc. (closed-end
investment company);
Director of three
open-end investment
companies managed by
First Pacific Advisors,
Inc.; formerly Chairman
of the Board of Directors
(or Trustees) of nineteen
investment companies
managed by American
Capital Asset Management,
Inc.
Richard E. Stierwalt 40 Executive Chairman of the Board
125 W. 55th Street Vice President and Chief Executive
New York, NY 10019 Officer, July 1993 to
date, prior thereto
Senior Director, Managing
Director and Chief
Executive Officer of the
Administrator and
Distributor, February
1987 to July 1993;
President, Master
Investment Trust, Series
I, Master Investment
Trust, Series II and
Seafirst Retirement Funds
(since 1993); First Vice
President, Trust
Operation Administration,
Security Pacific National
Bank, 1983-1987.
William B. Blundin 57 Executive Vice Vice Chairman, July 1993
125 W. 55th Street President to date, prior thereto
New York, NY 10019 Director and President
of the Administrator and
Distributor, February
1987 to July 1993;
Executive Vice
President, Master
Investment Trust, Series
II and Seafirst
Retirement Funds (since
1993); Senior Vice
</TABLE>
- 36 -
<PAGE> 167
<TABLE>
<CAPTION>
Position with
-------------
Name and Address Age Company Principal Occupations
- ---------------- --- ------- ---------------------
<S> <C> <C> <C>
President, Shearson
Lehman Brothers, 1978-
1987.
Irimga McKay 35 Vice Senior Vice President,
7863 Girard Avenue President July 1993 to date, prior
Suite 306 thereto First Vice
La Jolla, CA 92037 President of the
Administrator and
Distributor, November
1988 to July 1993; Vice
President, Master
Investment Trust, Series
II and Seafirst
Retirement Funds (since
1993); Regional Vice
President, Continental
Equities, June 1987 to
November 1988; Assistant
Wholesaler, VMS Realty
Partners (a real estate
limited partnership), May
1986 to June 1987.
W. Eugene Spurbeck 39 Assistant Vice Manager of Client
BISYS Fund Services President Services of the
515 Figueroa Street Administrator (1993 to
Suite 335 date); Assistant Vice
Los Angeles, CA 92307 President, Master
Investment Trust, Series
II; Vice President,
Seafirst Retirement Funds
(since 1995); Vice
President of Retail
Lending Operations Banc
One (1989 to 1993).
Martin R. Dean 31 Treasurer Manager of Fund
3435 Stelzer Road Accounting of BISYS
Columbus, OH 43219 Fund Services, May 1994
to Present; Treasurer,
Master Investment Trust,
Series II and Seafirst
Retirement Funds (since
1995); Senior Manager at
KPMG Peat Marwick
previously 1990-1994.
W. Bruce McConnel, III 52 Secretary Partner of the law firm
1345 Chestnut Street of Drinker Biddle &
Philadelphia National Bank Reath. Secretary,
Building, Suite 1100 Master Investment Trust,
Philadelphia, PA 19107 Series I, Master
Investment Trust, Series
</TABLE>
- 37 -
<PAGE> 168
<TABLE>
<CAPTION>
Position with
-------------
Name and Address Age Company Principal Occupations
- ---------------- --- ------- ---------------------
<S> <C> <C> <C>
II and Seafirst
Retirement Funds
George O. Martinez 35 Assistant Senior Vice President
3435 Stelzer Road Secretary and Director of Legal
Columbus, OH 43219 and Compliance Services,
of the Administrator.
since April 1995;
Assistant Secretary,
Master Investment Trust,
Series II and Seafirst
Retirement Funds (since
1995); prior thereto,
Vice President and
Associate General
Counsel, Alliance Capital
Management, L.P.
</TABLE>
- --------------------------------
* Mr. Pings is an "interested director" of the Company as defined in the
1940 Act.
The Audit Committee of the Board is comprised of all directors and is
chaired by Dr. Trefftzs. The Board does not have an Executive Committee.
Each director is entitled to receive an annual fee of $25,000 plus
$1,000 for each day that a director participates in all or a part of a Board
meeting; the President receives an additional $20,000 per annum for his services
as President; Mr. Collins, in consideration of his years of service as President
and Chairman of the Board, receives an additional $40,000 per annum in severance
until February 28, 1997; each member of a Committee of the Board is entitled to
receive $1,000 for each Committee meeting they participate in (whether or not
held on the same day as a Board meeting); and each Chairman of a Committee of
the Board shall be entitled to receive an annual retainer of $1,000 for his
services as Chairman of the Committee. The Funds, and each other fund of the
Company, pays its proportionate share of these amounts based on relative net
asset values.
For the fiscal year ended February 28, 1995, the Company paid or
accrued for the account of its directors as a group for services in all
capacities a total of $334,168. Of that amount, $18,530, $17,424 and $18,146 of
directors' compensation were allocated to the Flexible Bond, Blue Chip and Asset
Allocation Funds, respectively. Each director is also reimbursed for
out-of-pocket expenses incurred as a director. Drinker Biddle & Reath, of which
Mr. McConnel is a partner,
- 38 -
<PAGE> 169
receives legal fees as counsel to the Company. As of the date of this Statement
of Additional Information, the directors and officers of the Company, as a
group, own less than 1% of the outstanding shares of each of the Company's
investment portfolios.
Under a retirement plan approved by the Board, including a majority of
its directors who are not "interested persons" of the Company, effective March
1, 1995, a director who dies or resigns after five years of service is entitled
to receive ten annual payments each equal to the greater of: (i) 50% of the
annual director's retainer that was payable by the Company during the year of
his/her death or resignation, or (ii) 50% of the annual director's retainer then
in effect for directors of the Company during the year of such payment. A
director who dies or resigns after nine years of service is entitled to receive
ten annual payments each equal to the greater of: (i) 100% of the annual
director's retainer that was payable by the Company during the year of his/her
death or resignation, or (ii) 100% of the annual director's retainer then in
effect for directors of the Company during the year of such payment. Further,
the amount payable each year to a director who dies or resigns is increased by
$1,000 for each year of service that the director provided as Chairman of the
Board.
Years of service for purposes of calculating the benefit described
above are based upon service as a director or Chairman after February 28, 1994.
Retirement benefits in which a director has become vested may not be reduced by
later Board action.
In lieu of receiving ten annual payments, a director may elect to
receive substantially equivalent benefits through a single-sum cash payment of
the present value of such benefits paid by the Company within 45 days of the
death or resignation of the director. The present value of such benefits is to
be calculated (i) based on the retainer that was payable by the Company during
the year of the director's death or resignation (and not on any retainer payable
to directors thereafter), and (ii) using the interest rate in effect as of the
date of the director's death or resignation by the Pension Benefit Guaranty
Corporation (or any successor thereto) for valuing immediate annuities under
terminating defined benefit pension plans. A director's election to receive a
single sum must be made in writing within the 30 calendar days after the date
the individual is first elected as a director.
In addition to the foregoing, the Board of Directors may, in its
discretion and in recognition of a director's period of service before March 1,
1994 as a director and possibly as
- 39 -
<PAGE> 170
Chairman, authorize the Company to pay a retirement benefit following the
director's death or resignation (unless the director has vested benefits as a
result of completing nine years of service). Any such action shall be approved
by the Board and by a majority of the directors who are not "interested persons"
of the Company within 120 days following the director's death or resignation and
may be authorized as a single sum cash payment or as not more than ten annual
payments (beginning the first anniversary of the director's date of death or
resignation and continuing for one or more anniversary date(s) thereafter).
The obligation of the Company to pay benefits to a former director is
neither secured nor funded by this Company but shall be binding upon its
successors in interest. The payment of such benefits under the retirement plan
has no priority or preference over the lawful claims of the Company's creditors
or shareholders, and the right to receive such payments is not assignable or
transferable by a director (or former director) other than by will, by the laws
of descent and distribution, or by the director's written designation of a
beneficiary.
TRUSTEES AND OFFICERS OF MASTER INVESTMENT TRUST, SERIES I
The trustees and officers of Master Investment Trust, Series I, a
Delaware business trust of which the Portfolios are separate series, their
addresses, ages and principal occupation during the past five years are:
- 40 -
<PAGE> 171
<TABLE>
<CAPTION>
Position with
Name and Address Age the Master Trust Principal Occupations
- ---------------- --- ---------------- ---------------------
<S> <C> <C> <C>
Thomas M. Collins 61 Chairman of the See "Directors and
McDermott & Trayner Board Officers of the
255 South Lake Avenue, Company."
Suite 410
Pasadena, CA 91101
Michael Austin 59 Trustee Chartered Accountant;
Victory House, Trustee, Master
Nelson Quay Investment Trust, Series
Governor's Harbour II; Retired Partner, KPMG
Grand Cayman, Peat Marwick LLP.
Cayman Islands
British West Indies
Robert E. Greeley 62 Trustee See "Directors and
Page Mill Asset Officer of the Company."
Management
433 California Street
Suite 900
San Francisco, CA 94104
Robert A. Nathane* 70 Trustee Retired President, Laird
1200 Shenandoah Drive Norton Trust Company,
East Chairman of the Board of
Seattle, WA 98112 Advisors, Phoenix Venture
Funds; Trustee, Seafirst
Retirement Funds (since
1993); Trustee, Master
Investment Trust, Series
II (since 1993); former
Supervisor, Collective
Investment Trust for
Seafirst Retirement
Accounts; former Trustee,
First Funds of America
(registered investment
companies).
Cornelius J. Pings 66 Trustee See "Directors and
Association of American Officers of the
Universities Company."
One DuPont Circle
Suite 730
Washington, DC 20036
Richard E. Stierwalt 40 President See "Directors and
125 West 55th Street Officers of the
11th Floor Company."
New York, NY 10019
W. Bruce McConnel, III 52 Secretary See "Directors and
1345 Chestnut Street Officers of the
Philadelphia, PA 19107 Company."
</TABLE>
- 41 -
<PAGE> 172
<TABLE>
<CAPTION>
Position with
Name and Address Age the Master Trust Principal Occupations
- ---------------- --- ---------------- ---------------------
<S> <C> <C> <C>
Adrian J. Waters 32 Executive Vice Managing Director of
ITI House President, Concord Management
23 Earlsfort Terrace Treasurer and (Ireland) Limited since
Dublin 2, Ireland Assistant May 1993; Manager in
Secretary Investment Company
Industry Services Group,
Price Waterhouse, 1989-
1993; Member of Oliver
Freaney & Co./Spicer &
Oppenheim Chartered
Accountants, 1986-1989.
</TABLE>
- -----------------------------
* Mr. Nathane is an "interested trustee" of the Master Trust as defined in
the 1940 Act.
Each trustee receives an aggregate annual fee of $1,500 plus $500 per
meeting attended and $250 per day for each full day devoted to travel in
connection with each meeting attended, for his services as trustee of the Master
Trust. Each trustee is also reimbursed for out-of-pocket expenses incurred as a
trustee. The trustee's fees and reimbursements are allocated among all of the
Master Trust's Portfolios based on their relative net asset values. For its
fiscal year ended February 28, 1995, the Master Trust paid or accrued for the
account of its trustees as a group for services in all capacities a total of
$30,221; of that amount, $9,695, $9,195 and $9,670 were allocated to the
Portfolios corresponding to the Flexible Bond, Blue Chip and Asset Allocation
Funds.
The following chart provides certain information about the
director/trustee fees of the Company's and Master Trust's directors/trustees as
of February 28, 1995:
<TABLE>
<CAPTION>
============================================================================================================
TOTAL
COMPENSATION
PENSION OR FROM
RETIREMENT ESTIMATED REGISTRANT
AGGREGATE AGGREGATE BENEFITS ANNUAL AND FUND
COMPENSATION COMPENSATION ACCRUED AS BENEFITS COMPLEX*
NAME OF PERSON/ FROM THE FROM THE PART OF FUND UPON PAID TO
POSITION COMPANY MASTER TRUST EXPENSES RETIREMENT DIRECTORS
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Thomas M. Collins $100,000 $5,000 $0 $0 $110,000
President and
Chairman of the
Board+
- ------------------------------------------------------------------------------------------------------------
Douglas B. Fletcher $ 57,500 $0 $0 $0 $ 57,500
Vice Chairman of
the Board
============================================================================================================
</TABLE>
- 42 -
<PAGE> 173
<TABLE>
<CAPTION>
============================================================================================================
TOTAL
COMPENSATION
PENSION OR FROM
RETIREMENT ESTIMATED REGISTRANT
AGGREGATE AGGREGATE BENEFITS ANNUAL AND FUND
COMPENSATION COMPENSATION ACCRUED AS BENEFITS COMPLEX*
NAME OF PERSON/ FROM THE FROM THE PART OF FUND UPON PAID TO
POSITION COMPANY MASTER TRUST EXPENSES RETIREMENT DIRECTORS
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Robert E. Greeley** $57,500 $4,750 $0 $0 $65,781
Director
- ------------------------------------------------------------------------------------------------------------
Kermit O. Hanson $57,500 $0 $0 $0 $63,500
Director
- ------------------------------------------------------------------------------------------------------------
Cornelius J. Pings $57,500 $0 $0 $0 $57,500
Director
- ------------------------------------------------------------------------------------------------------------
Kenneth L. Trefftzs $57,500 $0 $0 $0 $57,500
Director
============================================================================================================
- ------------------------------
* The "Fund Complex" consists of the Company, Seafirst Retirement Funds, the Master Trust and
Master Investment Trust, Series II.
** Mr. Greeley became a director of the Company on April 25, 1994.
+ Mr. Collins was President and Chairman of the Board of the Company until August 31, 1995.
</TABLE>
INVESTMENT ADVISOR
Bank of America is the successor by merger to Security Pacific National
Bank ("Security Pacific"), which previously served as investment adviser to the
other investment portfolios of the Company since the commencement of its
operations. As described in the Prospectuses, the Funds have not retained the
services of an investment adviser since they seek to achieve their investment
objectives by investing all their assets in their corresponding Portfolio. In
the Investment Advisory Agreement with the Portfolios, Bank of America has
agreed to provide investment advisory services as described in each Prospectus.
Bank of America has also agreed to pay all expenses incurred by it in connection
with its activities under its agreements other than the cost of securities,
including brokerage commissions, if any, purchased for the Portfolios. In
rendering its advisory services, Bank of America may utilize Bank officers from
one or more of the departments of the Bank which are authorized to exercise the
fiduciary powers of Bank of America with respect to the investment of trust
assets. In some cases, these officers may also serve as officers, and utilize
the facilities, of wholly-owned subsidiaries and other affiliates of Bank of
America or its parent corporation. In addition, the agreement also provides that
Bank of America may, in its discretion, provide advisory services through its
own employees or employees of one or more of its affiliates that are under the
- 43 -
<PAGE> 174
common control of Bank of America's parent, BankAmerica Corporation; provided
such employees are under the management of Bank of America.
For the services provided and expenses assumed pursuant to the
investment advisory agreement, the Portfolios have agreed to pay Bank of America
investment advisory fees, accrued daily and paid monthly, at the annual rates of
.45% of the net assets of the Investment Grade Bond Portfolio (the Portfolio
corresponding to the Flexible Bond Fund); .75% of the net assets of the Blue
Chip Portfolio; and .55% of the net assets of the Asset Allocation Portfolio.
The fees payable to Bank of America are not subject to reduction as the value of
each Fund's or Portfolio's net assets increases. From time to time, Bank of
America may waive fees or reimburse the Portfolios for expenses voluntarily or
as required by certain state securities laws.
For the fiscal year ended February 28, 1995, Bank of America waived its
entire investment advisory fees in the amounts of $293,222, $1,091,132 and
$849,188 for the Portfolios corresponding to the Flexible Bond, Blue Chip and
Asset Allocation Funds, respectively. Additionally, for the periods indicated,
Bank of America assumed certain operating expenses with respect to the Flexible
Bond, Blue Chip and Asset Allocation Funds in the amounts of $207,033, $245,776
and $245,718, respectively.
For the period from December 6, 1993 (commencement of the Portfolios'
operations) to February 28, 1994, Bank of America waived its entire investment
advisory fees in the amounts of $84,856, $225,019 and $197,611 for the
Portfolios corresponding to the Flexible Bond, Blue Chip and Asset Allocation
Funds, respectively. Additionally, for the periods indicated, Bank of America
assumed certain operating expenses with respect to the Flexible Bond, Blue Chip
and Asset Allocation Funds in the amounts of $24,300, $31,726 and $28,384,
respectively.
See "Management - Administrator" for instances where the investment
adviser is required to make expense reimbursements to the Portfolios.
For the period from December 6, 1993 (commencement of operations)
through April 11, 1994, Bank of America had a Sub-Advisory Agreement with
Seattle Capital Management Company ("Seattle Capital") with respect to
management of the assets of the Portfolios corresponding to the Flexible Bond
Fund and of that portion of the assets of the Portfolio corresponding to the
Asset Allocation Fund which Bank of America determined from time to time to be
appropriate for investment in debt securities (including money market
instruments). The Sub-Advisory Agreement
- 44 -
<PAGE> 175
provided that Bank of America would pay Seattle Capital a monthly advisory fee
based upon the net assets of such Portfolios, at the annual rate of .45% of the
net assets of the Portfolio corresponding to the Flexible Bond Fund, and .55% of
that portion of the net assets of the Portfolio corresponding to the Asset
Allocation Fund managed by Seattle Capital. For the period December 6, 1993
(commencement of operations) through February 28, 1994, Bank of America paid
Seattle Capital sub-advisory fees of $0 and $0 for sub-advisory services to the
Investment Grade Bond and Asset Allocation Portfolios, respectively.
The Investment Advisory Agreements for the Portfolios provide that Bank
of America shall not be liable for any error of judgment or mistake of law or
for any loss suffered in connection with the performance of the investment
advisory agreements, except a loss resulting from a breach of fiduciary duty
with respect to the receipt of compensation for services or a loss resulting
from willful misfeasance, bad faith or negligence in the performance of its
duties or from reckless disregard by it of its duties and obligations
thereunder.
THE GLASS-STEAGALL ACT AND PROPOSED LEGISLATION
The Glass-Steagall Act, among other things, prohibits banks from
engaging in the business of underwriting securities, although national and
state-chartered banks generally are permitted to purchase and sell securities
upon the order and for the account of their customers. In 1971, the United
States Supreme Court held in Investment Company Institute v. Camp that the
Glass-Steagall Act prohibits a national bank from operating a fund for the
collective investment of managing agency accounts. Subsequently, the Board of
Governors of the Federal Reserve System (the "Board") issued a regulation and
interpretation to the effect that the Glass-Steagall Act and such decision
forbid a bank holding company registered under the Federal Bank Holding Company
Act of 1956 (the "Holding Company Act") or any non-bank affiliate thereof from
sponsoring, organizing or controlling a registered, open-end investment company
continuously engaged in the issuance of its shares, but do not prohibit such a
holding company or affiliate from acting as investment adviser, transfer agent
and custodian to such an investment company. In 1981, the United States Supreme
Court held in Board of Governors of the Federal Reserve System v. Investment
Company Institute that the Board did not exceed its authority under the Holding
Company Act when it adopted its regulation and interpretation authorizing bank
holding companies and their non-bank affiliates to act as investment advisers to
registered closed-end investment companies.
- 45 -
<PAGE> 176
Bank of America believes that if the question was properly presented, a
court should hold that Bank of America may perform the services for the
Portfolios and the Company contemplated by the Investment Advisory Agreement,
the Prospectuses, and this Statement of Additional Information without violation
of the Glass-Steagall Act or other applicable banking laws or regulations. It
should be noted, however, that there have been no cases deciding whether a
national bank may perform services comparable to those performed by Bank of
America and that future changes in either federal or state statutes and
regulations relating to permissible activities of banks or trust companies and
their subsidiaries or affiliates, as well as further judicial or administrative
decisions or interpretations of present and future statutes and regulations,
could prevent Bank of America from continuing to perform such services for the
Portfolios and the Company or from continuing to purchase Fund shares for the
accounts of its customers.
For a discussion of the Glass-Steagall Act in connection with the
Company's Shareholder Service Plans, see "Plan Payments" in the Funds'
Prospectuses.
On the other hand, as described herein, the Funds are currently
distributed by Concord Financial Group, Inc. Concord Holding Corporation, its
parent, either directly or through its off-shore subsidiary, provides the
Portfolios and the Funds with administrative services. If current restrictions
under the Glass-Steagall Act preventing a bank from sponsoring, organizing,
controlling, or distributing shares of an investment company were relaxed, the
Portfolios and the Company expect that Bank of America would consider the
possibility of offering to perform some or all of the services now provided by
Concord Holding Corporation or Concord Financial Group, Inc. From time to time,
legislation modifying such restriction has been introduced in Congress which, if
enacted, would permit a bank holding company to establish a non-bank subsidiary
having the authority to organize, sponsor and distribute shares of an investment
company. If this or similar legislation were enacted, the Portfolios and the
Company expect that Bank of America's parent bank holding company would consider
the possibility of one of its non-bank subsidiaries offering to perform some or
all of the services now provided by Concord Holding Corporation or Concord
Financial Group, Inc. It is not possible, of course, to predict whether or in
what form such legislation might be enacted or the terms upon which Bank of
America or such a non-bank affiliate might offer to provide services for
consideration by the Company's Board of Directors or the Portfolios' Board of
Trustees.
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<PAGE> 177
ADMINISTRATOR
Concord Holding Corporation (the "Administrator"), with offices at 125
W. 55th Street, New York, New York 10019 and 3435 Stelzer Road, Columbus, Ohio
43219, is a wholly-owned subsidiary of The BISYS Group, Inc. The Administrator
also serves as administrator to several other investment companies.
The Administrator and its off-shore subsidiary provide administrative
services to the Company and the Portfolios as described in the Funds'
Prospectuses pursuant to separate administration agreements for the Company and
the Portfolios. The Portfolios' administration agreement will continue in
effect until October 31, 1996 and thereafter for successive periods of one year,
provided the agreement is not sooner terminated. The Portfolios' administration
agreement is terminable at any time with respect to any Portfolio by the
Portfolios' Board of Trustees or by a vote of a majority of that Portfolio's
outstanding interests upon 60 days' notice to the Administrator, or by the
Administrator upon 90 days' notice to the Portfolio. The Funds' administration
agreement will continue in effect until October 31, 1996 and thereafter will be
extended with respect to each Fund for successive periods of one year, provided
that each such extension is specifically approved (a) by vote of a majority of
those members of the Company's Board of Directors who are not interested persons
of any party to the agreement, cast in person at a meeting called for the
purpose of voting on such approval, and (b) the Company's Board of Directors or
by vote of a majority of the outstanding voting securities of such Fund. The
agreement is terminable at any time without penalty by the Company's Board of
Directors or by a vote of a majority of a Fund's outstanding shares upon 60
days' notice to the Administrator, or by the Administrator upon 90 days' notice
to the Company.
The Company has agreed to pay the Administrator a fee for its services
as Administrator, accrued daily and payable monthly, at the annual rates of .15%
of the average daily net assets of the Flexible Bond, Blue Chip, and Asset
Allocation Funds. In addition, the Portfolios that correspond to the Flexible
Bond, Blue Chip and Asset Allocation Funds have each agreed to pay the
Administrator a fee for its services as Administrator, accrued daily and payable
monthly, at the annual rate of .05% of the average daily net assets of the
respective Portfolio. The fees payable to the Administrator are not subject to
reduction as the value of the Funds' and the Portfolios' net assets increases.
From time to time, the Administrator may waive fees or reimburse the Portfolios
or the Company for expenses, either voluntarily or as required by certain state
securities laws.
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<PAGE> 178
For the fiscal year ended February 28, 1995, the Administrator waived
its entire administration fees in the amounts of $33,431, $72,742 and $79,573
for the Portfolios corresponding to the Flexible Bond, Blue Chip and Asset
Allocation Funds, respectively.
For the period from December 6, 1993 (commencement of the Portfolios'
operations) to February 28, 1994, the Administrator waived its entire
administration fees in the amounts of $9,429, $15,001 and $17,965 for the
Portfolios corresponding to the Flexible Bond, Blue Chip and Asset Allocation
Funds, respectively.
For the fiscal year ended February 28, 1995, the Administrator waived
its entire administration fees in the amounts of $1,723, $5,833 and $4,703 for
the Flexible Bond, Blue Chip and Asset Allocation Funds, respectively.
For the period from the commencement of operations for the particular
Fund (January 24, 1994, January 13, 1994 and January 18, 1994 for the Flexible
Bond, Blue Chip and Asset Allocation Funds, respectively) to February 28, 1994,
the Administrator waived its entire administration fees in the amounts of $22,
$87 and $52 for the Flexible Bond, Blue Chip and Asset Allocation Funds,
respectively.
If total expenses borne by any Fund in any fiscal year exceed the
expense limitations imposed by applicable state securities regulations, the
Company and the Portfolio may deduct from the payments to be made with respect
to such Fund and its corresponding Portfolio to Bank of America and the
Administrator, respectively, or Bank of America and the Administrator will bear
the amount of such excess to the extent required by such regulations in
proportion to the fees otherwise payable to them for such year. Such amount, if
any, will be estimated, reconciled and effected or paid, as the case may be, on
a monthly basis. As of the date of this Statement of Additional Information,
the most restrictive expense limitation that may be applicable to the Company or
the Portfolios limits aggregate annual expenses with respect to a Fund
(including management, advisory fees and the Funds' pro-rata share of such
expenses of their corresponding Portfolios but excluding interest, taxes,
brokerage commissions, and certain other expenses) to 2-1/2% of the first $30
million of its average daily net assets, 2% of the next $70 million, and 1-1/2%
of its remaining average daily net assets. During the course of the Company's
fiscal year, the Administrator and Bank of America may assume certain expenses
and/or not receive payment of fees of one or more of the Portfolios or Funds,
while retaining the ability to be reimbursed by such Portfolios or Funds for
such amounts prior to the end of
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<PAGE> 179
the fiscal year. This will have the effect of increasing yield to investors at
the time such fees are not received or amounts are assumed and decreasing yield
when such fees or amounts are reimbursed.
The Administrator will bear all expenses in connection with the
performance of its services under the administration agreements with the
exception of the fees charged by PFPC, for certain fund accounting services
which are borne by the Portfolios and the Funds. See "General
Information--Custodian and Transfer Agent" below. Expenses borne by the Funds
and Portfolios include taxes, interest, brokerage fees and commissions, if any,
fees of Board members who are not officers, directors, partners, employees or
holders of 5% or more of the outstanding voting securities of Bank of America or
the Administrator or any of their affiliates, Securities and Exchange Commission
fees and state securities qualification fees, advisory fees, administration
fees, charges of custodians, transfer and dividend disbursing agents' fees,
certain insurance premiums, outside auditing and legal expenses, costs of
maintaining corporate existence, costs attributable to investor services,
including without limitation telephone and personnel expenses, costs of
preparing and printing prospectuses and Statements of Additional Information for
regulatory purposes, cost of shareholders' reports and corporate meetings and
any extraordinary expenses. Certain shareholder servicing fees in connection
with the Company's shares are also paid by the Company. See "Distributor and
Plan Payments."
The administration agreements provide that the Administrator shall not
be liable for any error of judgment or mistake of law or any loss suffered by
the Company or the Portfolios in connection with the performance of the
administration agreements, except a loss resulting from willful misfeasance, bad
faith or negligence in the performance of its duties or from the reckless
disregard by it of its obligations and duties thereunder.
DISTRIBUTOR AND PLAN PAYMENTS
Concord Financial Group, Inc. (the "Distributor"), a wholly-owned
subsidiary of the Administrator, acts as distributor of the shares of the
Company. Shares are sold on a continuous basis by the Distributor. The
Distributor has agreed to use its best efforts to solicit orders for the sale of
the Company's shares although it is not obliged to sell any particular amount of
shares. The distribution agreement shall continue in effect with respect to
each Fund until October 31, 1996. Thereafter, if not terminated, the
distribution agreement shall continue automatically for successive terms of one
year, provided that
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<PAGE> 180
such continuance is specifically approved at least annually (a) by a vote of a
majority of those members of the Board of Directors of the Company who are not
parties to the distribution agreement or "interested persons" of any such
party, cast in person at a meeting called for the purpose of voting on such
approval, and (b) by the Board of Directors of the Company or by vote of a
"majority of the outstanding voting securities" of the Funds as to which the
distribution agreement is effective; provided, however, that the distribution
agreement may be terminated by the Company at any time, without the payment of
any penalty, by vote of a majority of the entire Board of Directors of the
Company or by a vote of a "majority of the outstanding voting securities" of
such Funds on 60 days' written notice to the Distributor, or by the Distributor
at any time, without the payment of any penalty, on 90 days' written notice to
the Company. The agreement will automatically and immediately terminate in the
event of its "assignment."
For the fiscal year ended February 28, 1995, the Distributor received
$53,285, $186,628 and $114,338 in sales loads in connection with share purchases
of the Flexible Bond, Blue Chip and Asset Allocation Funds, respectively, of
which the Distributor and various affiliates of Bank of America retained $5,470
and $47,815 respectively, for the Flexible Bond Fund, $121,377 and $165,251,
respectively, for the Blue Chip Fund, and $30,504 and $83,884, respectively, for
the Asset Allocation Fund.
For the period from commencement of operations of the particular Fund
(January 14, 1994, January 13, 1994 and January 18, 1994 for Flexible Bond, Blue
Chip and Asset Allocation Funds, respectively) to February 28, 1994, the
Distributor received $14,623, $22,924 and $11,896 in sales loads in connection
with share purchases of the Flexible Bond, Blue Chip and Asset Allocation Funds,
respectively, of which the Distributor and various affiliates of Bank of America
retained $1,628 and $12,995, respectively, for the Flexible Bond Fund, $2,692
and $20,232, respectively, for the Blue Chip Fund, and $2,243 and $9,653,
respectively, for the Asset Allocation Fund.
The Distributor is entitled to payment by the Company for certain
shareholder servicing expenses in addition to the sales loads described above
and in the Prospectuses under the Shareholder Service Plan (the "Plan") adopted
by the Company. Under the Shareholder Service Plan, the Company pays the
Distributor, with respect to each of the Flexible Bond, Blue Chip and Asset
Allocation Funds, for (a) non-distribution shareholder services provided by the
Distributor to Service Organizations and/or the beneficial owners of Fund
shares, including, but not limited to shareholder servicing provided by the
Distributor at
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<PAGE> 181
facilities dedicated for Company use, provided such shareholder servicing is
not duplicative of the servicing otherwise provided on behalf of the Funds, and
(b) fees paid to Service Organizations (which may include the Distributor
itself) for the provision of support services, based on the average daily value
of the Funds shares beneficially owned by shareholders for whom the Service
Organization is the dealer of record or holder of record or with whom the
Service Organization has a servicing relationship ("Clients").
Support services provided by Service Organizations may include, among
other things: (i) establishing and maintaining accounts and records relating to
Clients that invest in Fund shares; (ii) processing dividend and distribution
payments from the Funds on behalf of Clients; (iii) providing information
periodically to Clients regarding their positions in shares; (iv) arranging for
bank wires; (v) responding to Client inquiries concerning their investments in
Fund shares; (vi) providing the information to the Funds necessary for
accounting or subaccounting; (vii) if required by law, forwarding shareholder
communications from the Funds (such as proxies, shareholder reports, annual and
semi-annual financial statements and dividend, distribution and tax notices) to
Clients; (viii) assisting in processing exchange and redemption requests from
Clients; (ix) assisting Clients in changing dividend options, account
designations and addresses; and (x) providing such other similar services.
The Shareholder Service Plan provides that the Distributor is entitled
to receive payments for expenses on a monthly basis, at an annual rate not
exceeding .25% of the average daily net assets during such month of the Flexible
Bond, Blue Chip and Asset Allocation Funds, for shareholder servicing expenses.
The calculation of a Fund's average daily net assets for these purposes does not
include assets held in accounts opened via a transfer of assets from trust and
agency accounts of Bank of America. Further, payments made out of or charged
against the assets of a particular Fund must be in payment for expenses incurred
on behalf of the Fund.
If in any month the Distributor expends or is due more monies than can
be immediately paid due to the percentage limitations described above, the
unpaid amount is carried forward from month to month while the Plan is in effect
until such time, if ever, when it can be paid in accordance with such percentage
limitations. Conversely, if in any month the Distributor does not expend the
entire amount then available under the Plan, and assuming that no unpaid amounts
have been carried forward and remain unpaid, then the amount not expended will
be a credit to be drawn upon by the Distributor to permit future payment.
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<PAGE> 182
However, any unpaid amounts or credits due under the Plan may not be "carried
forward" beyond the end of the fiscal year in which such amounts or credits due
are accrued.
For the fiscal year ended February 28, 1995, the Distributor waived all
fees due under the Plan in the amounts of $2,873, $9,721 and $7,754,
respectively for the Flexible Bond, Blue Chip and Asset Allocation Funds.
For the period from commencement of operations of the particular Fund
(January 24, 1994, January 13, 1994 and January 18, 1994 for Flexible Bond, Blue
Chip and Asset Allocation Funds, respectively) to February 28, 1994, the
Distributor waived all fees due under the Plan in the amounts of $36, $146 and
$86 respectively for the Flexible Bond, Blue Chip and Asset Allocation Funds.
Payments for Shareholder Service expenses are not subject to Rule 12b-1
(the "Rule") under the 1940 Act. (Although such provisions are not required by
the Rule, the Shareholder Service Plan contains similar provisions to the Rule,
including quarterly review by the Board of the Company of amounts expended and
the purposes for such expenditures, except that shareholder approval is not
required to increase materially the Shareholder Service expenses paid by the
Funds.)
The Shareholder Service Plans are subject to annual re-approval by a
majority of the directors who are neither "interested persons" (as that term is
defined in the 1940 Act) of the Company nor have any direct or indirect
financial interest in the operation of the Shareholder Service Plan (the
"Non-Interested Plan Directors") and are terminable at any time with respect to
any Fund by a vote of majority of such Directors or by vote of the holders of a
majority of the shares of the Fund involved. Any agreement entered into
pursuant to the Plans with a Service Organization is terminable with respect to
any Fund without penalty, at any time, by vote of a majority of the
Non-Interested Plan Directors, by vote of the holders of a majority of the
shares of such Fund, by the Distributor or by the Service Organization. Each
agreement will also terminate automatically in the event of its assignment.
The Company understands that Bank of America and/or some Service
Organizations may charge their clients a direct fee for administrative and
shareholder services in connection with the holding of Fund shares. These fees
would be in addition to any amounts which might be received under the Plans.
Small, inactive long-term accounts involving such additional charges may not be
in the best interest of shareholders.
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<PAGE> 183
The following table shows all sales loads, commissions and other
compensation received by the Distributor directly or indirectly from each of
these Funds during their most recent fiscal year ended February 28, 1995:
<TABLE>
<CAPTION>
Brokerage
Net Under- Commissions
writing Dis- Compensation in connection
counts and on Redemption with Fund Other
Commissions and Repurchase Transactions Compensation(1)
------------ -------------- ------------- ---------------
<S> <C> <C> <C> <C>
Concord Financial
Group, Inc.
Flexible Bond $ 5,470 $0 $0 $0
Fund
Blue Chip Fund $121,377 $0 $0 $0
Asset Allocation $30,504 $0 $0 $0
Fund
</TABLE>
- -------------------
(1) Represents the total of (i) amounts paid to the Administrator
for administrative services provided to the Fund (see
"Management-Administrator" above) and (ii) payments made under the
Shareholder Service Plans (see discussion above).
YIELD AND TOTAL RETURN
From time to time, the yields and the total returns of the Funds may be
quoted in and compared to other mutual funds with similar investment objectives
in advertisements, shareholder reports or other communications to shareholders.
The Funds may also include calculations in such communications that describe
hypothetical investment results. (Such performance examples will be based on an
express set of assumptions and are not indicative of the performance of any
Fund.) Such calculations may from time to time include discussions or
illustrations of the effects of compounding in advertisements. "Compounding"
refers to the fact that, if dividends or other distributions on a Fund
investment are reinvested by being paid in additional Fund shares, any future
income or capital appreciation of a Fund would increase the value, not only of
the original Fund investment, but also of the additional Fund shares received
through reinvestment. As a result, the value of the Fund investment would
increase more quickly than if dividends or other distributions had been paid in
cash. The Funds may also include discussions or illustrations of the potential
investment goals of a prospective investor (including but not limited to tax
and/or retirement planning), investment management techniques, policies or
investment suitability of a Fund, economic conditions, legislative
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<PAGE> 184
developments (including pending legislation), the effects of inflation and
historical performance of various asset classes, including but not limited to
stocks, bonds and Treasury bills. From time to time advertisements or
communications to shareholders may summarize the substance of information
contained in shareholder reports (including the investment composition of a Fund
and a Portfolio), as well as the views of the investment adviser as to current
market, economic, trade and interest rate trends, legislative, regulatory and
monetary developments, investment strategies and related matters believed to be
of relevance to a Fund. The Funds may also include in advertisements charts,
graphs or drawings which illustrate the potential risks and rewards of
investment in various investment vehicles, including but not limited to stocks,
bonds, Treasury bills and shares of a Fund. In addition, advertisements or
shareholder communications may include a discussion of certain attributes or
benefits to be derived by an investment in a Fund and may include testimonials
as to the investment adviser's capabilities by clients. Such advertisements or
communications may include symbols, headlines or other material which highlight
or summarize the information discussed in more detail therein. With proper
authorization, a Fund may reprint articles (or excerpts) written regarding the
Fund and provide them to prospective shareholders. Performance information with
respect to these Funds is generally available by calling (800) 346-2087.
Yield Calculations. The yield of a Fund is calculated by dividing the
net investment income per share (as described below) earned by the Fund during a
30-day (or one month) period by the maximum offering price per share on the last
day of the period and annualizing the result on a semi-annual basis by adding
one to the quotient, raising the sum to the power of six, subtracting one from
the result and then doubling the difference. The Fund's net investment income
per share earned during the period is based on the average daily number of
shares outstanding during the period entitled to receive dividends and includes
dividends and interest earned during the period minus expenses accrued for the
period, net of reimbursements. This calculation can be expressed as follows:
a-b
Yield = 2 [(----- + 1)(6) - 1]
cd
Where: a = dividends and interest earned during the period.
b = expenses accrued for the period (net of
reimbursements).
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<PAGE> 185
c = the average daily number of shares outstanding during
the period that were entitled to receive dividends.
d = maximum offering price per share on the last day of the
period.
For the purpose of determining net investment income earned during the
period (variable "a" in the formula), dividend income on equity securities is
recognized by accruing 1/360 of the stated dividend rate of the security each
day. Except as noted below, interest earned on debt obligations is calculated
by computing the yield to maturity of each obligation based on the market value
of the obligation (including actual accrued interest) at the close of business
on the last business day of each month, or, with respect to obligations
purchased during the month, the purchase price (plus actual accrued interest),
and dividing the result by 360 and multiplying the quotient by the market value
of the obligation (including actual accrued interest) in order to determine the
interest income on the obligation for each day of the subsequent month that the
obligation is held. For purposes of this calculation, it is assumed that each
month contains 30 days. The maturity of an obligation with a call provision is
the next call date on which the obligation reasonably may be expected to be
called or, if none, the maturity date. With respect to debt obligations
purchased at a discount or premium, the formula generally calls for amortization
of the discount or premium. The amortization schedule will be adjusted monthly
to reflect changes in the market values of such debt obligations.
Interest earned on tax-exempt obligations that are issued without
original issue discount and have a current market discount is calculated by
using the coupon rate of interest instead of the yield to maturity. In the case
of tax-exempt obligations that are issued with original issue discount but which
have discounts based on current market value that exceed the then-remaining
portion of the original issue discount (market discount), the yield to maturity
is the imputed rate based on the original issue discount calculation. On the
other hand, in the case of tax-exempt obligations that are issued with original
issue discount but which have the discounts based on current market value that
are less than the then-remaining portion of the original issue discount (market
premium), the yield to maturity is based on the market value.
With respect to mortgage or other receivables-backed obligations which
are expected to be subject to monthly payments of principal and interest ("pay
downs"), (a) gain or loss attributable to actual monthly pay downs are accounted
for as an
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<PAGE> 186
increase or decrease to interest income during the period; and (b) a Fund or
Portfolio may elect either (i) to amortize the discount and premium on the
remaining security, based on the cost of the security, to the weighted average
maturity date, if such information is available, or to the remaining term of
the security, if any, if the weighted average maturity date is not available,
or (ii) not to amortize discount or premium on the remaining security.
Undeclared earned income will be subtracted from the maximum offering
price per share (variable "d" in the formula). Undeclared earned income is the
net investment income which, at the end of the base period, has not been
declared as a dividend, but is reasonably expected to be and is declared and
paid as a dividend shortly thereafter. A Fund's maximum offering price per
share for purposes of the formula includes the maximum sales load imposed by the
Fund -- currently 4.50% of the per share offering price.
Based on the foregoing calculations, the yields of the Flexible Bond
and Asset Allocation Funds (after fee waivers and expense reimbursements) for
the 30 day period ended February 28, 1995 were 6.96% and 4.07%, respectively.
Total Return Calculations. The Funds compute their average annual
total returns by determining the average annual compounded rates of return
during specified periods that equate the initial amount invested to the ending
redeemable value of such investment. This is done by dividing the ending
redeemable value of a hypothetical $1,000 initial payment by $1,000 and raising
the quotient to a power equal to one divided by the number of years (or
fractional portion thereof) covered by the computation and subtracting one from
the result. This calculation can be expressed as follows:
ERV (1/n)
T = [(-----) - 1]
P
Where: T = average annual total return.
ERV = ending redeemable value at the end of
the period covered by the computation of a
hypothetical $1,000 payment made at the
beginning of the period.
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<PAGE> 187
P = hypothetical initial payment of $1,000.
n = period covered by the computation, expressed
in terms of years.
The Funds compute their aggregate total returns by determining the
aggregate 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:
ERV
aggregate total return = [(----- - 1)]
P
The calculations of average annual total return and aggregate total
return assume the reinvestment of all dividends and capital gain distributions
on the reinvestment dates during the period. The ending redeemable value
(variable "ERV" in each formula) is determined by assuming complete redemption
of the hypothetical investment and the deduction of all nonrecurring charges at
the end of the period covered by the computations. In addition, the Funds'
average annual total return and aggregate total return quotations reflect the
deduction of the maximum sales load charged in connection with the purchase of
Fund shares.
Based on the foregoing calculations, the average annual total returns
for the Flexible Bond Fund for the one year period ended February 28, 1995 and
for the period January 24, 1994 (commencement of operations) through February
28, 1994 were (2.33)% and (2.33)%, respectively. The aggregate total returns
for the Flexible Bond Fund for the same periods were (2.33)% and (5.54)%,
respectively.
Based on the foregoing calculations, the average annual total returns
for the Blue Chip Fund for the one year period ended February 28, 1995 and for
the period January 13, 1994 (commencement of operations) through February 28,
1994 were 2.75% and N/A, respectively. The aggregate total returns for the Blue
Chip Fund for the same periods were 2.75% and (4.69)%, respectively.
Based on the foregoing calculations, the average annual total returns
for the Asset Allocation Fund for the one year period ended February 28, 1995
and for the period January 18, 1994 (commencement of operations) through
February 28, 1994 were 0.30% and N/A, respectively. The aggregate total returns
for the Asset Allocation Fund for the same periods were 0.30% and (5.54)%,
respectively.
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<PAGE> 188
The Funds may also advertise total return data without reflecting the
sales load imposed on the purchase of shares of the Funds in accordance with the
rules of the Securities and Exchange Commission. Quotations which do not reflect
the sales load will, of course, be higher than quotations which do.
GENERAL INFORMATION
DESCRIPTION OF SHARES
The Company is an open-end management investment company organized as a
Maryland corporation on October 27, 1982. The Company's Charter authorizes the
Board of Directors to issue up to two hundred billion full and fractional common
shares. Pursuant to the authority granted in the Charter, the Board of Directors
has authorized the issuance of twenty-two classes of stock, Classes A through W
Common Stock, $.001 par value per share, representing interests in twenty-two
separate investment portfolios. Class M represents interests in the Flexible
Bond Fund; Class N represents interests in the Blue Chip Fund; and Class O
represents interests in the Asset Allocation Fund. The Company's charter also
authorizes the Board of Directors to classify or reclassify any particular class
of the Company's shares into one or more series.
Shares have no preemptive rights and only such conversion or exchange
rights as the Board may grant in its discretion. When issued for payment as
described in the Prospectuses, the Company's shares will be fully paid and
non-assessable. For information concerning possible restrictions upon the
transferability of the Company's shares and redemption provisions with respect
to such shares, see "Additional Purchase and Redemption Information."
Shareholders are entitled to one vote for each full share held, and
fractional votes for fractional shares held, and will vote in the aggregate and
not by class or series except as otherwise required by the 1940 Act or other
applicable law or when permitted by the Board of Directors. Shares have
cumulative voting rights to the extent they may be required by applicable law.
Rule 18f-2 under the 1940 Act provides that any matter required to be
submitted to the holders of the outstanding voting securities of an investment
company such as the Company shall not be deemed to have been effectively acted
upon unless approved by a majority of the outstanding shares of each Fund
affected by the matter. A Fund is affected by a matter unless it is clear that
the interests of each Fund in the matter are substantially
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<PAGE> 189
identical or that the matter does not affect any interest of the Fund. Under
Rule 18f-2 the approval of an investment advisory agreement or 12b-1
distribution plan or any change in a fundamental investment policy would be
effectively acted upon with respect to a Fund only if approved by a majority of
the outstanding shares of such Fund. However, the rule also provides that the
ratification of independent public accountants, the approval of principal
underwriting contracts and the election of directors may be effectively acted
upon by shareholders of the Company voting without regard to particular Funds.
Notwithstanding any provision of Maryland law requiring a greater vote
of the Company's common stock (or of the shares of a Fund voting separately as a
class) in connection with any corporate action, unless otherwise provided by law
(for example, by Rule 18f-2 discussed above) or by the Company's Charter, the
Company may take or authorize such action upon the favorable vote of the holders
of more than 50% of the outstanding common stock of the Company voting without
regard to class.
THE PORTFOLIOS
The Portfolios are separate series of Master Investment Trust, Series
I, which was organized October 26, 1992 as a Delaware business trust. The Master
Trust's Declaration of Trust authorizes its Board of Trustees to issue an
unlimited number of shares of beneficial interest and to classify and reclassify
any authorized and unissued shares of beneficial interest into one or more
classes of shares. Investors in a Portfolio (such as the Flexible Bond, Blue
Chip or Asset Allocation Funds) are entitled to distributions arising from the
net investment income and net realized gains, if any, earned on investments held
by the Portfolio in which such investor holds beneficial interests. Investors
are also entitled to participate in the net distributable assets of the
Portfolio in which they hold beneficial interests on liquidation. Beneficial
interests have no preemptive rights, conversion or exchange rights.
CUSTODIAN, ACCOUNTING AGENT AND TRANSFER AGENT
The Company has appointed PNC Bank, N.A., Broad & Chestnut Streets,
Philadelphia, PA 19101 as custodian for the Flexible Bond, Blue Chip and Asset
Allocation Funds and their corresponding Portfolios. PFPC, 103 Bellevue
Parkway, Wilmington, DE 19809, provides these respective Funds and Portfolios
with certain accounting services pursuant to Fund Accounting Services Agreements
with the Administrator. Both PNC Bank, N.A. and PFPC are wholly owned
subsidiaries of PNC Bancorp, Inc., a bank holding company. Under the Fund
Accounting Services Agreement, PFPC has agreed to provide certain accounting,
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<PAGE> 190
bookkeeping, pricing, dividend and distribution calculation services with
respect to the Company and the Portfolios. The monthly fees charged by PFPC
under the Fund Accounting Agreements are borne by the Funds and Portfolios. As
custodian of the Company's assets, PNC Bank, N.A., (i) maintains a separate
account or accounts in the name of the respective Funds and Portfolios, (ii)
holds and disburses portfolio securities; (iii) makes receipts and disbursements
of money, (iv) collects and receives income and other payments and distributions
on account of portfolio securities, (v) responds to correspondence from security
brokers and others relating to their respective duties and (vi) makes periodic
reports concerning their duties.
BISYS Fund Services Ohio, Inc., 3435 Stelzer Road, Columbus, Ohio
43219-3035 serves as transfer and dividend disbursing agent for the Funds.
COUNSEL
Drinker Biddle & Reath (of which W. Bruce McConnel, III, Secretary of
the Company, is a partner), 1345 Chestnut Street, Suite 1100, Philadelphia,
Pennsylvania 19107, serves as counsel to the Company and the Master Trust and
will pass upon the legality of the shares offered hereby.
INDEPENDENT ACCOUNTANTS
Price Waterhouse LLP with offices at 1177 Avenue of the Americas, New
York, New York 10036, has been selected as independent accountants of each Fund
and their corresponding Portfolios for the fiscal year ended February 28, 1996.
REPORTS
Shareholders will be sent unaudited semi-annual reports describing the
Portfolios' and the Funds' investment operations, and annual financial
statements together with the reports of the independent accountants of the
Portfolios and the Funds.
MISCELLANEOUS
As used in the Prospectuses and this Statement of Additional
Information, a "vote of a majority" of the outstanding shares of a Fund, a
Portfolio or a particular series means the affirmative vote of the lesser of (a)
more than 50% of the outstanding interests or shares of a Portfolio, Fund or
such series, or (b) 67% of the interests or shares of a Portfolio, Fund or
series present at a meeting at which more than 50% of the outstanding interests
or shares of a Portfolio, Fund or series are represented in person or by proxy.
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<PAGE> 191
At June 15, 1995, the name, address and share ownership of the entities
which held of record more than 5% of the outstanding Pacific Horizon Shares of
the Treasury Fund were as follows: BA Investment Services Inc., For the Benefit
of Clients, 555 California Street, 4th Floor, Department #4337, San Francisco,
CA 94104, 98,230,626.530 shares (7.70%); Bank of America State Trust Co., 299 N.
Euclid Avenue, Pasadena, CA 91101, 1,044,975,154.790 shares (82.00%); and
Hellman & Freidman Capital Partners II, Limited Partnership, Attention: Georgia
Lee, 1 Maritime Plaza, 12th Floor, San Francisco, CA 94111, 1,216,118,073.700
shares (095.42%).
At June 16, 1995, the name, address and share ownership of the entities
which held of record more than 5% of the outstanding Horizon Shares of the
Treasury Fund was as follows: Bank of America Trustee/Custodian for Investing
in Horizon Treasury, Attn: Eric Peterson, 701 S. Western Avenue, 2nd Floor,
Glendale, CA 91201, 398,540,438.170 shares (68.901%); Security Pacific State
Trust Co., Agreement for Sec. PACWA Participants, Attn: Cash Sweep Funds (L.
Goekjian), P.O. Box 91630, Pasadena, CA 91101, 94,279,024.120 shares (16.299%).
At June 16, 1995, the name, address and share ownership of the entities
which held beneficially more than 5% of the outstanding Horizon Service Shares
of the Treasury Fund were as follows: Bank of America FM&TS Operat CA, Attn: CTF
Unit, 701 South Western Avenue, Glendale, CA 91201, 65,745,555.320 shares
(23.658%); Bank of America Nevada Southern Comm. Bank, Attn: Dan Dykes, P.O. Box
98600, Las Vegas, NV 89193, 63,974,589.270 shares (23.020%). Security Pacific
State Trust Co., Agreement for Sec. PACWA Participants, Attn: Cash Sweep Funds,
P.O. Box 91630, Pasadena, CA 91101, 56,906,301.540 shares (20.477%); and
Security Pacific Cash Management, c/o Bank of America - GPO M/C 5533, Attn:
Liezel Barangan, 1850 Gateway Boulevard, Concord, CA 94520, 77,003,300 shares
(27.709%). At June 15, 1995, the name, address and, share ownership of the
entity which held of record more than 5% of the outstanding Horizon Service
Shares of the Treasury Fund was as follows: Omnibus A/C for the Shareholder
Accounts maintained by Concord Financial Services, Inc., Attn: Linda Zerbe,
First and Market Building, 100 First Avenue, Suite 300, Pittsburgh, PA 15222,
263,629,755.130 shares (65.51%). At June 15, 1995 the name, address and share
ownership of the entities which held of record more than 5% of the outstanding
Pacific Horizon Shares of the Prime Fund were as follows: BA Investment
Services Inc., For the Benefit of Clients, 555 California Street, 4th Floor,
Department #4337, San Francisco, CA 94104, 514,119,226.900 shares (38.76%); Bank
of America State Trust Co., 299 N. Euclid Avenue, Pasadena, CA 91101,
392,983,248.780 shares (29.63%); and Southwest Securities Inc., Attn:
Cashiering, 201 Elm Street, Suite 4300, Dallas, TX 75270, 169,018,910.270
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<PAGE> 192
shares (12.74%). At June 16, 1995, the name, address and share ownership of the
entities which held of record more than 5% of the outstanding Horizon Shares of
the Prime Fund were as follows: Bank of America Trustee/Custodian for Investing
Horizon Prime, Attn: Eric Peterson, 701 S. Western Avenue, 2nd Floor, Glendale,
CA 91201, 385,058,852.030 shares (56.838%); and Bank of America NT&SA, Attn: Kay
Warren/Dept. #5596, 1455 Market Street, San Francisco, CA 94103, 57,300,000.00
shares (9.934%). At June 15, 1995, the name, address and share ownership of the
entity which held of record more than 5% of the outstanding Horizon Service
Shares of the Prime Fund were as follows: Omnibus A/C for the Shareholder
Accounts maintained by Concord Financial Services, Inc., Attn: Linda Zerbe,
First and Market Building, 100 First Avenue, Suite 300, Pittsburgh, PA 15222,
752,776,315.610 shares (70.26%).
At June 16, 1995, the name, address and share ownership of the entities
which held beneficially more than 5% of the outstanding Horizon Service Shares
of the Prime Fund were as follows: Bank of America NT&SA Financial Management
and Trust Services, 701 S. Western Avenue, Glendale, CA 91201, 74,038,082.090
shares (9.835%); Capital Network Services, Attn: Donna Novell, One Bush Street,
11th Floor, San Francisco, CA 94104, 86,407,261.23 shares (11.478%); Security
Pacific Cash Management, c/o Bank of America. GPO. M/C 5533 Attn: Liezel
Barangan, 1850 Gateway Boulevard, M/C 5533, Concord, CA 94520, 379,755,600.000
shares (50.447%); Security Pacific State Trust Co., Agreement for SecPAC WA
Participants, Attn: Cash Sweep Funds (L. Goekjian) P.O. Box 91630, Pasadena, CA
91101, 54,321,621.330 shares (7.216%); and Southwest Securities Inc., Attn: Mary
Lisenber, 1201 Elm Street, Suite 4300, Dallas, TX 75270, 130,146,660.030 shares
(17.289%).
At June 15, 1995, the name, address and share ownership of the entities
which held of record more than 5% of the outstanding Pacific Horizon Shares of
the Tax-Exempt Money Fund were as follows: BA Investment Services, Inc., For
the Benefit of Clients, 555 California Street, 4th Floor, Department #4337, San
Francisco, CA 94104, 12,233,845.190 shares (39.73%); Southwest Securities Inc.,
Attn: Cashiering, 1201 Elm Street, Suite 4300, Dallas, TX, 75270, 10,387,253.930
shares (33.73%); and Bank of America State Trust Co., 299 N. Euclid Avenue,
Pasadena, CA 91101, 6,515,635.730 shares (21.16%).
At June 16, 1995, the name, address and share ownership of the
entities which held of record more than 5% of the outstanding Horizon Shares of
the Tax-Exempt Money Fund were as follows: Bank of America Custodian For
Investing in Horizon Tax- Exempt Money Fund, Attn: Eric Peterson, 701 S. Western
Avenue, 2nd Floor, Glendale, CA 19201, 129,582,555.65 shares (38.576%);
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<PAGE> 193
Continental Bank National Association Custodian for the Benefit of Custodian
Co. Attn: Mary Chester, 231 South LaSalle Street, 6Q, Chicago, IL 60697,
152,699,416.270 shares (45.458%); and Maine Midland Bank NA, Investment
Services, 17th Floor, Attn: Christine Mincel, One Marine Midland Center,
Buffalo, NY 14203, 21,684,672.980 shares (6.455%).
At June 15, 1995, the name, address and share ownership of the entities
which held of record more than 5% of the outstanding shares of the Horizon
Service Shares of the Tax-Exempt Money Fund were as follows: Furman C. Moseley
and Susan R. Moseley Tenn. In Common, 1201 3rd Avenue, Box 7C, Seattle, WA
98101, 4,165,513.060 shares (9.91%); Omnibus A/C for the shareholder accounts
maintained by Concord Financial Services Inc., Attn: Linda Zerbe, First and
Market Building, 100 First Avenue, Suite 300, Pittsburgh, PA 15222,
22,398,544.590 shares (53.31%); and Omnibus A/C for the Shareholder Accounts
maintained by Concord Financial Services Inc. Attn: First and Market Building,
100 First Avenue, Suite 300, Pittsburgh, PA 15222, 3,494,305.180 shares (8.31%).
At June 16, 1995, the name, address and share ownership of the entities which
held beneficially more than 5% of the outstanding Horizon Service Shares of the
Tax-Exempt Money Fund were as follows: BA Investment Services Inc., 555
California Street, 4th Floor Dept. #4337, San Francisco, CA 94104,
1,362,028.590 shares (5.260%); Bank of America FM&TS Oper. CA, Attn: CTF Unit,
701 South Western Avenue, Glendale, CA 91201, 2,293,907.40 shares (8.859%); and
Southwest Securities, Inc., Attn: Mary Lisenber, 1201 Elm Street, Suite 430,
Dallas, TX 75270, 21,021,580.530 shares (81.187%). At June 15, 1955, the name,
address and share ownership of the entities which held of record more than 5% of
the outstanding Pacific Horizon Shares of the Government Fund were as follows:
Bank of America, NT&SA, The Private Bank, Attn: ACI Unit #8329, 701 S. Western
Avenue, Glendale, CA 91201, 79,875,532.090 shares (22.71%); Bank of America
State Trust Co., 299 N. Euclid Avenue., Pasadena, CA 91101, 64,756,966.280
shares (18.41%); and BA Investment Services Inc., For the Benefit of Clients,
555 California Street, 4th Floor, Department #4337, San Francisco, CA 94104,
170,940,404.650 shares (48.60%). At June 16, 1995, the name, address and share
ownership of the entities which held of record more than 5% of the outstanding
Horizon Shares of the Government Fund were as follows: Bank of America NT&SA
Trustee/Custodian for Investing in Horizon Shares of the Government Fund, Attn:
Cynthia Beauvais, 701 South Western Avenue., Glendale, CA 91201, 9,327,446.350
shares (5.028%); Bank of America State Trust, Attn: Rigo Barrett, 299 N. Euclid
Avenue, Pasadena, CA 91101, 28,063,486.740 shares (15.129%); Capital Network
Services, Attn: Donna Novell, One Bush Street, 11th Floor, San Francisco, CA
94104, 24,227,801.980 shares (13.061%); County of Orange, Matt Raabe, P.O. Box
4515, Santa Ana, CA 92702,
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<PAGE> 194
10,000,000.000 shares (5.391%); Cypress Insurance Co., Attn: Larry Tetzloff,
9290 W. Dodge Road, Omaha, NE 68124, 9,996,515.930 shares (5.389%); Harr & Co.,
c/o Bank of New York, Attn: Bimal Sana, Spec. Prec. Dept., One Wall Street, 5th
Floor, New York, NY 10286, 14,000,000.000 shares (7.547%); Micron Electronics
Inc., Attn: Debbie Meigand, 900 East Karcher Road, Nanpa, ID 83687,
16,080,510.14 shares (8.669%); and Silocin Magic Corp., Attn: Meng A. Lim, 20300
Stevens Creek Boulevard., Suite 400, Cupertino, CA 95014, 18,058,262.110 shares
(9.735%). At June 15, 1995, the name, address and share ownership of the
entities which held of record more than 5% of the outstanding Horizon Service
Shares of the Government Fund were as follows: Spacelabs Medical, Inc., Attn:
Scott Bender, P.O. Box 97013, Redmond, WA 98073, 14,572,000.000 shares (5.70%);
Good Health Plan of WA, Attn: Tsai Cheng, 1501 9th Avenue, Suite 500, Seattle,
WA 98101, 16,584,866.580 shares (6.49%); Omnibus A/C for the Shareholder
Accounts maintained by Concord. Financial Services Inc., Attn: Linda Zerbe,
First and Market Building, 100 First Avenue, Suite 300, Pittsburgh, PA 15222,
68,555,257.020 shares (26.85%). At June 16, 1995, the name, address and share
ownership of the entities which held beneficially more than 5% of the Horizon
Service Shares of the Government Fund were as follows: Bank of America Nevada
Southern Comm. Bank, Attn: Dan Dykes, P.O. Box 98600, Las Vegas, NV 89193-8600,
35,849,966.050 shares (52.294%); and Capital Network Services, Attn: Donna M.
Howell, One Bush Street, 11th Floor, San Francisco, CA 94104-4425,
23,929,840.440 shares (34.906%). At June 15, 1995, the name, address and share
ownership of the entities which held of record more than 5% of the Pacific
Horizon Shares of the Treasury Only Fund were as follows: Bank of America NT&SA,
the Private Bank, Attn: ACI Unit 48329, 701 South Western Avenue, Glendale, CA
91201, 48,516,900.490 shares (31.68%) Bank of America State Trust Co., 299 N.
Euclid Avenue, Pasadena, CA 91101, 22,350,831.320 shares (14.59%); and BA
Investment Services Inc., For the Benefit of Clients, 555 California Street, 4th
Floor, Department #4337, San Francisco, CA 94104, 69,016,521.500 shares
(45.06%). At June 15, 1995, the name, address and share ownership of the
entities which held of record more than 5% of the outstanding Horizon Service
Shares of the Treasury Only Fund were as follows: National Home Mortgage Corp.,
Attn: Mortgage Banking Treasury Operations, 5565 Morehouse Drive, 3rd Floor, San
Diego, CA 92121, 12,147.667,580 shares (9.42%); Comcare, Inc., 4001 N. 3rd
Street, Suite 120, Phoenix, AZ 85012, 26,230,243.620 shares (20.34%); and
Omnibus A/C For the Shareholder Accounts Maintained by Concord Financial
Services Inc., Attn: Linda Zerbe, First and Market Building, 100 First Avenue,
Suite 300, Pittsburgh, PA 15222, 21,883,084.450 shares (16.97%). At June 16,
1995, the name, address and share ownership of the entities which held
beneficially more than 5% of the outstanding Horizon Service Shares of the
Treasury Only Fund were as follows:
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<PAGE> 195
BA Investment Service Inc., 555 California Street, 4th Floor Dept. #4337, San
Francisco, CA 94104, 6,403,628.120 shares (28.679%); Bank of America NT&SA
Trustee/Custodian for Investing in Horizon Service Shares of the Treasury Only
Fund, Attn: Cynthia Beauvais, 701 South Western Avenue, Glendale, CA 91201,
3,501,414.020 shares (15.681%); Bank of America State Trust, Attn: Rigo Barrett,
299 N. Euclid Avenue, Pasadena, CA 91101, 5,420,893.150 shares (24.277%); Fair
Isaac & Co., Attn: Christine Tam, 120 North Redwood, San Rapheal, CA 94903-1996,
1,338,800.750 shares (5.996%); Foothill/Eastern Transportation Corridor Agency,
Attn: Laura Barker, 201 East Sandpot, Suite 200, Santa Anna, CA 92707,
2,559,586.380 shares (11.463%); and Nexus, Attn: Kathleen Menace, P.O. Box
60637, Sunnyvale, CA 94088-0637, 2,525,153.380 shares (11.309%). At June 15,
1995, the name, address and share ownership of the entities which held of record
more than 5% of the outstanding Pacific Horizon Shares of the Prime Value Fund
were as follows: BA Investment Services Inc., For the Benefit of Clients, 555
California Street, 4th Floor, Department #4337, San Francisco, CA 94104,
16,383,467.170 shares (26.45%); and Bank of America State Trust Co., Attn: Leon
Goekjian, P.O. Box 91630, Pasadena, CA 91101, 45,078,465.290 shares (72.79%). At
June 16, 1995, the name, address and share ownership of the entity which held
of record more than 5% of the outstanding Horizon Shares of the Prime Value Fund
was as follows: Tice & Co., c/o M&T, Attn: Cash Management Clerk, 8th Floor,
P.O. Box 1377, Buffalo, NY 14240, 453,078,561.590 shares (93.510%). At June 15,
1995, the name, address and share ownership of the entity which held of record
more than 5% of the outstanding shares of the Pacific Horizon Shares of the
California Tax-Exempt Money Market Fund was as follows: BA Investment Services
Inc., For the Benefit of Clients, 555 California Street, 4th Floor, Department
#4337, San Francisco, CA 94104, 204,443,886.590 shares (22.07%). At June 15,
1995, the name, address and share ownership of the entities which held of record
more than 5% of the outstanding shares of the Horizon Service Shares of the
California Tax-Exempt Money Market Fund were as follows: Leo Zuckerman Trust,
DTD 12-11-91,4444 Viewridge Avenue, San Diego, CA 92123, 4,850,877.280 shares
(5.35%); and Omnibus A/C for the Shareholder Accounts Maintained by Concord
Financial Services Inc. Attn: Linda Zerbe, First and Market Building, 100 First
Avenue, Suite 300, Pittsburgh, PA 15222, 13,391,453.970 shares (14.77%). At June
16, 1995, the name, address and share ownership of the entity which held
beneficially more than 5% of the outstanding shares of the Horizon Service
Shares of the California Tax-Exempt Money Market Fund was as follows: BA
Investment Services Inc., 555 California Street, 4th Floor, Dept. #4337, San
Francisco, CA 94109, 13,792,509.310 shares (99.206%). At June 15, 1995, the
name, address and shares ownership of the entities which held of record more
than 5% of the outstanding shares of the Flexible Bond Fund were as follows:
Peter F. Smith and Jacquelyn L.
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<PAGE> 196
Smith, JTWROS, 1785 C. Blodgett Road, Mount Vernon, WA 98273, 13,973.917 shares
(5.58%); and BA Investment Services, Inc., FBO 200724011, 185 Berry Street, 3rd
Floor #2640, San Francisco, CA 94104, 22,436.531 shares (8.96%). At June 15,
1995 the name, address and share ownership of the entity which held of record
more than 5% of the outstanding shares of the Asset Allocation Fund was as
follows: Bank of America, Texas AATTEE. National-O'Neill Supplemental Savings
Plan, Attn: Mutual Funds (81-6-01005-0), P.O. Box 94627, Pasadena, CA 91109,
24,289,973 shares (5.07%). At June 15, 1995 the name, address and share
ownership of the entities which held of record more than 5% of the outstanding
shares of the National Municipal Bond Fund were as follows: BA Investment
Services, Inc. FBO 405084421, 555 California Street, 4th Floor, #2640, San
Francisco, CA 94104, 26,336.154 shares (8.31%); and BA Investment Services,
Inc., FBO 405266591, 555 California Street, 4th Floor, #2640, San Francisco, CA
94104, 25,034.024 shares (7.90%). At June 15, 1995 the name, address and share
ownership of the entities which held of record more than 5% of the outstanding
shares of the Corporate Bond Fund were as follows: Dean Witter Reynolds Inc.,
5 World Trade Center, 4th Floor, Attn: 5th O Div., New York, NY 10048,
138,820.000 shares (6.93%); and Smith Barney Shearson, Inc., 333 W. 39th Street,
8th Floor, New York, NY 10001, 148,925.482 shares (7.43%).
At such date, no other person was known by the Company to hold of
record or beneficially more than 5% of the outstanding shares of any investment
portfolio of the Company.
The Prospectuses relating to the Funds and this Statement of Additional
Information omit certain information contained in the Company's registration
statement filed with the SEC. Copies of the registration statement, including
items omitted herein, may be obtained from the Commission by paying the charges
prescribed under its rules and regulations.
FINANCIAL STATEMENTS AND EXPERTS
The Annual Reports for the Funds and the Portfolios for the fiscal year
ended February 28, 1995 accompanies this Statement of Additional Information.
The financial statements and notes thereto in the Annual Reports are
incorporated in this Statement of Additional Information by reference, and have
been audited by Price Waterhouse LLP, whose reports thereon also appear in such
Annual Reports and are also incorporated herein by reference. Such financial
statements have been incorporated herein in reliance on the reports of Price
Waterhouse LLP, independent accountants, given on the authority of said firm as
experts in auditing and accounting.
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APPENDIX A
COMMERCIAL PAPER RATINGS
A Standard & Poor's commercial paper rating is a current assessment of
the likelihood of timely payment of debt considered short-term in the relevant
market. The following summarizes the rating categories used by Standard and
Poor's for commercial paper:
"A-1" - Issue's degree of safety regarding timely payment is strong.
Those issues determined to possess extremely strong safety characteristics are
denoted "A-1+."
"A-2" - Issue's capacity for timely payment is satisfactory. However,
the relative degree of safety is not as high as for issues designated "A-1."
"A-3" - Issue has an adequate capacity for timely payment. It is,
however, somewhat more vulnerable to the adverse effects of changes and
circumstances than an obligation carrying a higher designation.
"B" - Issue has only a speculative capacity for timely payment.
"C" - Issue has a doubtful capacity for payment.
"D" - Issue is in payment default.
Moody's commercial paper ratings are opinions of the ability of issuers
to repay punctually promissory obligations not having an original maturity in
excess of 9 months. The following summarizes the rating categories used by
Moody's for commercial paper:
"Prime-1" - Issuer or related supporting institutions are considered to
have a superior capacity for repayment of short-term promissory obligations.
Prime-1 repayment capacity will normally 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.
"Prime-2" - Issuer or related supporting institutions are considered to
have a strong capacity for repayment of short-
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<PAGE> 198
term promissory 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 alternative liquidity is maintained.
"Prime-3" - Issuer or related supporting institutions have an
acceptable capacity for repayment of short-term promissory obligations. The
effects of industry characteristics and market composition may be more
pronounced. Variability in earnings and profitability may result in changes in
the level of debt protection measurements and the requirement for relatively
high financial leverage. Adequate alternate liquidity is maintained.
"Not Prime" - Issuer does not fall within any of the Prime rating
categories.
The three rating categories of Duff & Phelps for investment grade
commercial paper and short-term debt are "D-1," "D-2" and "D-3." Duff & Phelps
employs three designations, "D-1+," "D-1" and "D-1-," within the highest rating
category. The following summarizes the rating categories used by Duff & Phelps
for commercial paper:
"D-1+" - Debt possesses 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 issue as investment grade. Risk factors are larger and subject
to more variation. Nevertheless, timely payment is expected.
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<PAGE> 199
"D-4" - Debt possesses speculative investment characteristics.
Liquidity is not sufficient to ensure 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 short-term ratings apply to debt obligations that are payable on
demand or have original maturities of up to three years. The following
summarizes the rating categories used by Fitch for short-term obligations:
"F-1+" - Securities possess exceptionally strong credit quality. Issues
assigned this rating are regarded as having the strongest degree of assurance
for timely payment.
"F-1" - Securities possess very strong credit quality. Issues assigned
this rating reflect an assurance of timely payment only slightly less in degree
than issues rated "F-1+."
"F-2" - Securities possess good credit quality. Issues assigned this
rating have a satisfactory degree of assurance for timely payment, but the
margin of safety is not as great as the "F-1+" and "F-1" categories.
"F-3" - Securities possess fair credit quality. Issues assigned this
rating have characteristics suggesting that the degree of assurance for timely
payment is adequate; however, near-term adverse changes could cause these
securities to be rated below investment grade.
"F-S" - Securities possess weak credit quality. Issues assigned this
rating have characteristics suggesting a minimal degree of assurance for timely
payment and are vulnerable to near-term adverse changes in financial and
economic conditions.
"D" - Securities are in actual or imminent payment default.
Fitch may also use the symbol "LOC" with its short-term ratings to
indicate that the rating is based upon a letter of credit issued by a commercial
bank.
Thomson BankWatch short-term ratings assess the likelihood of an
untimely or incomplete payment of principal or interest of unsubordinated
instruments having a maturity of one year or less which is issued by United
States commercial banks, thrifts and non-bank banks; non-United States banks;
and broker-
A-3
<PAGE> 200
dealers. The following summarizes the ratings used by Thomson BankWatch:
"TBW-1" - This designation represents Thomson BankWatch's highest
rating category and indicates a very high degree of likelihood that principal
and interest will be paid on a timely basis.
"TBW-2" - This designation indicates that while the degree of safety
regarding timely payment 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 the lowest investment grade
category and indicates that while the debt is more susceptible to adverse
developments (both internal and external) than obligations with higher ratings,
capacity to service principal and interest in a timely fashion is considered
adequate.
"TBW-4" - This designation indicates that the debt is regarded as
non-investment grade and therefore speculative.
IBCA assesses the investment quality of unsecured debt with an original
maturity of less than one year which is issued by bank holding companies and
their principal bank subsidiaries. The following summarizes the rating
categories used by IBCA for short-term debt ratings:
"A1" - Obligations are supported by the highest capacity for timely
repayment. Where issues possess a particularly strong credit feature, a rating
of A1+ is assigned.
"A2" - Obligations are supported by a good capacity for timely
repayment.
"A3" - Obligations are supported by a satisfactory capacity for timely
repayment.
"B" - Obligations for which there is an uncertainty as to the capacity
to ensure timely repayment.
"C" - Obligations for which there is a high risk of default or which
are currently in default.
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<PAGE> 201
CORPORATE AND MUNICIPAL LONG-TERM DEBT RATINGS
The following summarizes the ratings used by Standard & Poor's for
corporate and municipal debt:
"AAA" - This designation represents the highest rating assigned by
Standard & Poor's to a debt obligation and indicates an extremely strong
capacity to pay interest and repay principal.
"AA" - Debt is considered to have a very strong capacity to pay
interest and repay principal and differs from AAA issues only in small degree.
"A" - Debt is considered to have a strong capacity to pay interest and
repay principal although such issues are somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than debt in
higher-rated categories.
"BBB" - Debt is regarded as having an adequate capacity to pay interest
and repay principal. Whereas such issues normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher-rated categories.
"BB," "B," "CCC" "CC" and "C" - Debt is regarded, on balance, as
predominantly speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligation. "BB" indicates the
lowest degree of speculation and "C" the highest degree of speculation. While
such debt will likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major risk exposures to adverse
conditions.
"BB" - Debt has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure
to adverse business, financial or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. The "BB"
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied "BBB-" rating.
"B" - Debt has a greater vulnerability to default but currently has the
capacity to meet interest payments and principal repayments. Adverse business,
financial or economic conditions will likely impair capacity or willingness to
pay interest and repay principal. The "B" rating category is also used for debt
subordinated to senior debt that is assigned an actual or implied "BB" or "BB-"
rating.
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"CCC" - Debt has a currently identifiable vulnerability to default, and
is dependent upon favorable business, financial and economic conditions to meet
timely payment of interest and repayment of principal. In the event of adverse
business, financial or economic conditions, it is not likely to have the
capacity to pay interest and repay principal. The "CCC" rating category is also
used for debt subordinated to senior debt that is assigned an actual or implied
"B" or "B-" rating.
"CC" - This rating is typically applied to debt subordinated to senior
debt that is assigned an actual or implied "CCC" rating.
"C" - This rating is typically applied to debt subordinated to senior
debt which is assigned an actual or implied "CCC-" debt rating. The "C" rating
may be used to cover a situation where a bankruptcy petition has been filed, but
debt service payments are continued.
"CI" - This rating is reserved for income bonds on which no interest is
being paid.
"D" - Debt is in payment default. This rating is used when interest
payments or principal payments are not made on the date due, even if the
applicable grace period has not expired, unless S & P believes such payments
will be made during such grace period. "D" rating is also used upon the filing
of a bankruptcy petition if debt service payments 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 rating is attached to highlight derivative, hybrid, and
certain other obligations that S & P believes may experience high volatility or
high variability in expected returns due to non-credit risks. Examples of such
obligations are: securities whose principal or interest return is indexed to
equities, commodities, or currencies; certain swaps and options; and interest
only and principal only mortgage securities.
The following summarizes the ratings used by Moody's for corporate and
municipal long-term debt:
"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.
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"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 risks appear somewhat larger than in "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 considered medium-grade obligations, i.e., they are
neither highly protected nor poorly secured. Interest payments and principal
security appear adequate for the present but certain protective elements may be
lacking or may be characteristically unreliable over any 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 some speculative elements; "B" indicates a general lack of
characteristics of desirable investment; "Caa" represents a 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 (a) earnings of projects under construction, (b) earnings
of projects unseasoned in operation experience, (c) rentals which begin when
facilities are completed, or (d) payments to which some other limiting condition
attaches. Parenthetical rating denotes probable credit stature upon completion
of construction or elimination of basis of condition.
Moody's applies numerical modifiers 1, 2 and 3 in each generic
classification from "Aa" to "B" in its bond rating system. The modifier 1
indicates that the issuer ranks in the higher end of its generic rating
category; the modifier 2 indicates a mid-range ranking; and the modifier 3
indicates that the issuer ranks at the lower end of its generic rating category.
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The following summarizes the long-term debt ratings used by Duff &
Phelps 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 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 and greater in periods of 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 highest four ratings used by Fitch for
corporate and municipal bonds:
"AAA" - Bonds considered to be investment grade and of the highest
credit quality. The obligor has an exceptionally strong ability to pay interest
and repay principal, which is unlikely to be affected by reasonably foreseeable
events.
"AA" - Bonds considered to be investment grade and of very high credit
quality. The obligor's ability to pay interest and repay principal is very
strong, although not quite as strong as bonds rated "AAA." Because bonds rated
in the "AAA" and "AA" categories are not significantly vulnerable to foreseeable
future developments, short-term debt of these issuers is generally rated "F-1+."
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"A" - Bonds considered to be investment grade and of high credit
quality. The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse changes in
economic conditions and circumstances than bonds with higher ratings.
"BBB" - Bonds considered to be investment grade and of satisfactory
credit quality. The obligor's ability to pay interest and repay principal is
considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have an adverse impact on these
bonds, and therefore, impair timely payment. The likelihood that the ratings of
these bonds will fall below investment grade is higher than for bonds with
higher ratings.
"BB," "B," "CCC," "CC," "C," "DDD," "DD," and "D" - Bonds that possess
one of these ratings are considered by Fitch to be speculative investments. The
ratings "BB" to "C" represent Fitch's assessment of the likelihood of timely
payment of principal and interest in accordance with the terms of obligation for
bond issues not in default. For defaulted bonds, the rating "DDD" to "D" is an
assessment of the ultimate recovery value through reorganization or liquidation.
To provide more detailed indications of credit quality, the Fitch
ratings from and including "AA" to "C" may be modified by the addition of a plus
(+) or minus (-) sign to show relative standing within these major rating
categories.
IBCA assesses the investment quality of unsecured debt with an original
maturity of more than one year which is issued by bank holding companies and
their principal bank subsidiaries. The following summarizes the rating
categories used by IBCA for long-term debt ratings:
"AAA" - Obligations for which there is the lowest expectation of
investment risk. Capacity for timely repayment of principal and interest is
substantial such that adverse changes in business, economic or financial
conditions are unlikely to increase investment risk substantially.
"AA" - Obligations for which there is a very low expectation of
investment risk. Capacity for timely repayment of principal and interest is
substantial. Adverse changes in business, economic or financial conditions may
increase investment risk albeit not very significantly.
"A" - Obligations for which there is a low expectation of investment
risk. Capacity for timely repayment of principal and interest is strong,
although adverse changes in business,
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economic or financial conditions may lead to increased investment risk.
"BBB" - Obligations for which there is currently a low expectation of
investment risk. Capacity for timely repayment of principal and interest is
adequate, although adverse changes in business, economic or financial conditions
are more likely to lead to increased investment risk than for obligations in
higher categories.
"BB," "B," "CCC," "CC," and "C" - Obligations are assigned one of these
ratings where it is considered that speculative characteristics are present.
"BB" represents the lowest degree of speculation and indicates a possibility of
investment risk developing. "C" represents the highest degree of speculation
and indicates that the obligations are currently in default.
IBCA may append a rating of plus (+) or minus (-) to a rating to denote
relative status within major rating categories.
Thomson BankWatch 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 Thomson BankWatch for long-term debt ratings:
"AAA" - This designation represents the highest category assigned by
Thomson BankWatch to long-term debt and indicates that the ability to repay
principal and interest on a timely basis is very high.
"AA" - This designation indicates a superior ability to repay principal
and interest on a timely basis with limited incremental risk versus 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 Thomson BankWatch's lowest
investment grade category and indicates an acceptable capacity to repay
principal and interest. Issues rated "BBB" are, however, 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
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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.
"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 Standard and Poor'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 Standard & Poor's Ratings Group for municipal
notes:
"SP-1" - The issuers of these municipal notes exhibit very strong or
strong capacity to pay principal and interest. Those issues determined to
possess overwhelming safety characteristics are given a plus (+) designation.
"SP-2" - The issuers of these municipal notes exhibit satisfactory
capacity to pay principal and interest.
"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 Investors Service, Inc.
for short-term notes:
"MIG-1"/"VMIG-1" - Loans bearing this designation 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" - Loans bearing this designation are of high quality,
with margins of protection ample although not so large as in the preceding
group.
"MIG-3"/"VMIG-3" - Loans bearing this designation are of favorable
quality, with all security elements accounted for but lacking the undeniable
strength of the preceding grades.
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Liquidity and cash flow protection may be narrow and market access for
refinancing is likely to be less well established.
"MIG-4"/"VMIG-4" - Loans bearing this designation are of adequate
quality, carrying specific risk but having protection commonly regarded as
required of an investment security and not distinctly or predominantly
speculative.
"SG" - Loans bearing this designation are of speculative quality and
lack margins of protection.
Fitch and Duff & Phelps use the short-term ratings described under
Commercial Paper Ratings for municipal notes.
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APPENDIX B
As stated in the Prospectuses, the Portfolios corresponding to the
Flexible Bond Fund, Blue Chip Fund and Asset Allocation Fund may enter into
futures contracts and options for hedging purposes. 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 as a defense, or hedge, against anticipated interest rate changes and
not for speculation. 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, through using futures
contracts.
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.
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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
in the sale exceeds the price in the offsetting purchase, the Portfolio is 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's 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 and
the Chicago Mercantile 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 futures contract for
which there exists a public market, including, without limitation, the foregoing
instruments.
Examples of Futures Contract Sale. A Portfolio would engage in an
interest rate futures contract sale to maintain the income advantage from
continued holding of a long-term bond while endeavoring to avoid part or all of
the loss in market value that would otherwise accompany a decline in long-term
securities prices. Assume that the market value of a certain security in the
Portfolio corresponding to the Flexible Bond Fund tends to move in concert with
the futures market prices of long-term United States Treasury bonds ("Treasury
bonds"). The investment adviser wishes to fix the current market value of this
portfolio security until some point in the future. Assume the portfolio
security has a market value of 100, and the investment adviser believes that,
because of an anticipated rise in interest rates, the value will decline to 95.
The Portfolio might enter into futures contract sales of Treasury bonds for an
equivalent of 98. If the market value of the portfolio security does indeed
decline
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from 100 to 95, the equivalent futures market price for the Treasury bonds might
also decline from 98 to 93.
In that case, the five-point loss in the market value of the portfolio
security would be offset by the five-point gain realized by closing out the
futures contract sale. Of course, the futures market price of Treasury bonds
might well decline to more than 93 or to less than 93 because of the imperfect
correlation between cash and futures prices mentioned below.
The investment adviser could be wrong in its forecast of interest rates
and the equivalent futures market price could rise above 98. In this case, the
market value of the portfolio securities, including the portfolio security being
protected, would increase. The benefit of this increase would be reduced by the
loss realized on closing out the futures contract sale.
If interest rate levels did not change, the Portfolio in the above
example might incur a loss of 2 points (which might be reduced by an off-setting
transaction prior to the settlement date). In each transaction, transaction
expenses would also be incurred.
Examples of Futures Contract Purchase. A Portfolio would engage in an
interest rate futures contract purchase when it is not fully invested in
long-term bonds but wishes to defer for a time the purchase of long-term bonds
in light of the availability of advantageous interim investments, e.g.,
shorter-term securities whose yields are greater than those available on
long-term bonds. The Portfolio's basic motivation would be to maintain for a
time the income advantage from investing in the short-term securities; the
Portfolio would be endeavoring at the same time to eliminate the effect of all
or part of an expected increase in market price of the long-term bonds that the
Portfolio may purchase.
For example, assume that the market price of a long-term bond that the
Portfolio corresponding to the Flexible Bond Fund may purchase, currently
yielding 10%, tends to move in concert with futures market prices of Treasury
bonds. The investment adviser wishes to fix the current market price (and thus
10% yield) of the long-term bond until the time (four months away in this
example) when it may purchase the bond. Assume the long-term bond has a market
price of 100, and the investment adviser believes that, because of an
anticipated fall in interest rates, the price will have risen to 105 (and the
yield will have dropped to about 9 1/2%) in four months. The Portfolio might
enter into futures contracts purchases of Treasury bonds for an equivalent price
of 98. At the same time, the Portfolio would assign a pool of investments in
short-term securities that are either maturing in four months or earmarked for
sale in four
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months, for purchase of the long-term bond at an assumed market price of 100.
Assume these short-term securities are yielding 15%. If the market price of the
long-term bond does indeed rise from 100 to 105, the equivalent futures market
price for Treasury bonds might also rise from 98 to 103. In that case, the
5-point increase in the price that the Portfolio pays for the long-term bond
would be offset by the 5-point gain realized by closing out the futures contract
purchase.
The investment adviser could be wrong in its forecast of interest
rates; long-term interest rates might rise to above 10%; and the equivalent
futures market price could fall below 98. If short-term rates at the same time
fall to 10% or below, it is possible that the Portfolio would continue with its
purchase program for long-term bonds. The market price of available long- term
bonds would have decreased. The benefit of this price decrease, and thus yield
increase, will be reduced by the loss realized on closing out the futures
contract purchase.
If, however, short-term rates remained above available long-term rates,
it is possible that the Portfolio would discontinue its purchase program for
long-term bonds. The yield on short-term securities in the portfolio, including
those originally in the pool assigned to the particular long-term bond, would
remain higher than yields on long-term bonds. The benefit of this continued
incremental income will be reduced by the loss realized on closing out the
futures contract purchase. In each transaction, expenses would also be
incurred.
II. STOCK INDEX FUTURES CONTRACTS
A stock index assigns relative values to the stocks included in the
index and the index fluctuates with changes in the market values of the stocks
included. A stock index futures contract is a bilateral agreement pursuant to
which two parties agree to take or make delivery of an amount of cash equal to a
specified dollar amount times the difference between the stock index value
(which assigns relative values to the common stocks included in the index) at
the close of the last trading day of the contract and the price at which the
futures contract is originally struck. No physical delivery of the underlying
stocks in the index is made. Some stock index futures contracts are based on
broad market indices, such as the Standard & Poor's 500 or the New York Stock
Exchange Composite Index. In contrast, certain exchanges offer futures
contracts on narrower market indices, such as the Standard & Poor's 100 or
indices 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.
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The Portfolios corresponding to the Blue Chip Fund and Asset Allocation
Fund will sell stock index futures contracts in order to offset a decrease in
market value of their respective portfolio securities that might otherwise
result from a market decline. The Portfolios may do so either to hedge the
value of their respective portfolios as a whole, or to protect against declines,
occurring prior to sales of securities, in the value of the securities to be
sold. Conversely, the Portfolios will purchase stock index futures contracts in
anticipation of purchases of securities. In a substantial majority of these
transactions, the Portfolios will purchase such securities upon termination of
the long futures position, but a long futures position may be terminated without
a corresponding purchase of securities.
In addition, the Portfolios corresponding to the Blue Chip Fund and
Asset Allocation Fund may utilize stock index futures contracts in anticipation
of changes in the composition of their respective 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.
The Portfolios 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 their respective portfolios will decline
prior to the time of sale.
The following are examples of transactions in stock index futures (net
of commissions and premiums, if any).
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ANTICIPATORY PURCHASE HEDGE: Buy the Future
Hedge Objective: Protect Against Increasing Price
<TABLE>
<CAPTION>
Portfolio Futures
--------- -------
<S> <C>
-Day Hedge is Placed-
Anticipate Buying $62,500 Buying 1 Index Futures
Blue Chip Fund at 125
Value of Futures =
$62,500/Contract
-Day Hedge is Lifted-
Buy Blue Chip Fund with Sell 1 Index Futures at 130
Actual Cost = $65,000 Value of Futures = $65,000/
Increase in Purchase Price = Contract
$2,500 Gain on Futures = $2,500
HEDGING A STOCK PORTFOLIO: Sell the Future
Hedge Objective: Protect Against Declining
Value of the Fund
Factors:
Value of Stock Fund = $1,000,000
Value of Futures Contract = 125 x $500 = $62,500
Fund Beta Relative to the Index = 1.0
<CAPTION>
Portfolio Futures
--------- -------
<S> <C>
-Day Hedge is Placed-
Anticipate Selling $1,000,000 Sell 16 Index Futures at 125
Blue Chip Fund Value of Futures = $1,000,000
-Day Hedge is Lifted-
Blue Chip Fund-Own Buy 16 Index Futures at 120
Stock with Value = $960,000 Value of Futures = $960,000
Loss in Fund Value = $40,000 Gain on Futures = $40,000
</TABLE>
If, however, the market moved in the opposite direction, that
is, market value decreased and a Portfolio had entered into an anticipatory
purchase hedge, or market value increased and a Portfolio had hedged its stock
portfolio, the results of the Portfolio's transactions in stock index futures
would be as set forth below.
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ANTICIPATORY PURCHASE HEDGE: Buy the Future
Hedge Objective: Protect Against Increasing Price
<TABLE>
<CAPTION>
Portfolio Futures
--------- -------
<S> <C>
-Day Hedge is Placed-
Anticipate Buying $62,500 Buying 1 Index Futures at 125
Blue Chip Fund Value of Futures = $62,500/
Contract
-Day Hedge is Lifted-
Buy Blue Chip Fund with Sell 1 Index Futures at 120
Actual Cost - $60,000 Value of Futures = $60,000/
Decrease in Purchase Price = $2,500 Contract
Loss on Futures = $2,500
HEDGING A STOCK PORTFOLIO: Sell the Future
Hedge Objective: Protect Against Declining
Value of the Fund
Factors:
Value of Stock Fund = $1,000,000
Value of Futures Contract = 125 x $500 = $62,500
Fund Beta Relative to the Index = 1.0
<CAPTION>
Portfolio Futures
--------- -------
<S> <C>
-Day Hedge is Placed-
Anticipate Selling $1,000,000 Sell 16 Index Futures at 125
Blue Chip Fund Value of Futures = $1,000,000
-Day Hedge is Lifted-
Blue Chip Fund-Own Buy 16 Index Futures at 130
Stock with Value = $1,040,000 Value of Futures = $1,040,000
Gain in Fund Value = $40,000 Loss of Futures = $40,000
</TABLE>
III. MARGIN PAYMENTS
Unlike when a Portfolio purchases or sells a security, no price is paid
or received by the 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 Portfolio's custodian an amount of cash or cash
equivalents, the value of which may vary but is generally equal to 10% or less
of the value of the contract. This amount is known as initial margin. 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
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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 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 a 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 investment
advisor 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.
IV. RISKS OF TRANSACTIONS IN FUTURES CONTRACTS
There are several risks in connection with the use of futures in the
Portfolios as a hedging device. One risk arises because of the imperfect
correlation between movements in the price of the future and movements in the
price of the securities which are the subject of the hedge. The price of the
future may move more than or less than the price of the securities being hedged.
If the price of the future moves less than the price of the securities which are
the subject of the hedge, the hedge will not be fully effective but, if the
price of the securities 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 securities being hedged has moved in a favorable direction,
this advantage will be partially offset by the loss on the future. If the price
of the future moves more than the price of the hedged securities, the Portfolio
involved will experience either a loss or gain on the future which will not be
completely offset by movements in the price of the securities which are the
subject of the hedge. To compensate for the imperfect correlation of movements
in the price of securities 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 securities being hedged if the volatility over
a particular time period of the prices of such securities has been greater than
the volatility over such time period of the future, or if otherwise deemed to be
appropriate by the investment
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adviser. Conversely, a Portfolio may buy or sell fewer futures contracts if the
volatility over a particular time period of the prices of the securities 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 adviser. It is also
possible that, where the Portfolio has sold futures to hedge its portfolio
against a decline in the market, the market may advance and the value of
securities held in the Portfolio may decline. If this occurred, the Portfolio
would lose money on the future and also experience a decline in value in its
portfolio securities.
Where 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 securities (or options) in an orderly fashion, it is possible
that the market may decline instead; if the Portfolio then concludes not to
invest in securities or options 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
securities purchased.
In instances involving the purchase of futures contracts by a
Portfolio, an amount of cash and cash equivalents, equal to the market value of
the futures contracts, will be deposited in a segregated account with the
Portfolio's custodian and/or in a margin account with a broker to collateralize
the position and thereby insure that the use of such futures is unleveraged.
In addition to the possibility that there may be an imperfect
correlation, or no correlation at all, between movements in the futures and the
securities being hedged, the price of futures may not correlate perfectly with
movement in the cash market due to certain market distortions. 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
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futures, a correct forecast of general market trends or interest rate movements
by the 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, the 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.
Successful use of futures by a Portfolio is also subject to the
investment adviser's ability to predict correctly movements in the direction of
the market. For example, if a 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 of 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.
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V. OPTIONS ON FUTURES CONTRACTS
Each Portfolio may purchase 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.
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). In addition, the purchase
of an option also entails the risk that changes in the value of the underlying
futures contract will not be fully reflected 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 Portfolios because the maximum amount at risk is the
premium paid for the options (plus transaction costs). Although permitted by
their fundamental investment policies, the Portfolios do not currently intend to
write futures options, and will not do so in the future absent any necessary
regulatory approvals.
VI. OTHER HEDGING TRANSACTIONS
The Portfolios corresponding to the Blue Chip, Flexible Bond and Asset
Allocation Funds presently intend to use interest rate futures contracts and,
additionally, the Portfolios corresponding to the Blue Chip and Asset Allocation
Funds presently intend to use stock index futures contract in connection with
their hedging activities. Nevertheless, each of these Portfolios is authorized
to enter into hedging transactions in any other futures or options contracts
which are currently traded or which may subsequently become available for
trading. Such instruments may be employed in connection with the Portfolios'
hedging strategies if, in the judgment of the
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investment adviser, transactions therein are necessary or advisable.
VII. ACCOUNTING AND TAX TREATMENT
Accounting for futures contracts and related options will be in
accordance with generally accepted accounting principles.
Generally, futures contracts and options on futures contracts held by a
Portfolio at the close of the Portfolio's taxable year will be treated for
federal income tax purposes as sold for their fair market value on the last
business day of such year, a process known as "marking-to-market." Forty
percent of any gain or loss resulting from such constructive sale will be
treated as short-term capital gain or loss and 60% of such gain or loss will be
treated as long-term capital gain or loss without regard to the length of time
the Portfolio holds the futures contract or option ("the 40%-60% rule"). The
amount of any capital gain or loss actually realized by a Portfolio in a
subsequent sale or other disposition of those futures contracts or options will
be adjusted to reflect any capital gain or loss taken into account by a
Portfolio in a prior year as a result of the constructive sale of the contracts
or options. With respect to futures contracts to sell, which will be regarded
as parts of a "mixed straddle" because their values fluctuate inversely to the
values of specific securities held by a Portfolio, losses as to such contracts
to sell will be subject to certain loss deferral rules which limit the amount of
loss currently deductible on either part of the straddle to the amount thereof
which exceeds the unrecognized gain (if any) with respect to the other part of
the straddle, and to certain wash sales regulations. Under short sales rules,
which will also be applicable, the holding period of the securities forming part
of the straddle will (if they have not been held for the long-term holding
period) be deemed not to begin prior to termination of the straddle. With
respect to certain futures contracts and related options, deductions for
interest and carrying charges will not be allowed. Notwithstanding the rules
described above, with respect to futures contracts to sell which are properly
identified as such, a Portfolio may make an election which will exempt (in whole
or in part) those identified futures contracts from being treated for federal
income tax purposes as sold on the last business day of the Portfolio's taxable
year, but gains and losses will be subject to such short sales, wash sales and
loss deferral rules and the requirement to capitalize interest and carrying
charges. Under Temporary Regulations, a Portfolio would be allowed (in lieu of
the foregoing) to elect either (1) to offset gains or losses from portions which
are part of a mixed straddle by separately identifying each mixed straddle to
which such treatment applies, or (2) to establish a mixed straddle
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account for which gains and losses would be recognized and offset on a periodic
basis during the taxable year. Under either election, the 40%-60% rule will
apply to the net gain or loss attributable to the futures contracts, but in the
case of a mixed straddle account election, not more than 50 percent of any net
gain may be treated as long-term and no more than 40 percent of any net loss may
be treated as short-term.
With respect to the Portfolios corresponding to the Flexible Bond Fund
and Asset Allocation Fund, some investments may be subject to special rules
which govern the federal income tax treatment of certain transactions
denominated in terms of a currency other than the U.S. dollar or determined by
reference to the value of one or more currencies other than the U.S. dollar. The
types of transactions covered by the special rules include the following: (i)
the acquisition of, or becoming the obligor under, a bond or other debt
instrument (including, to the extent provided in Treasury regulations, preferred
stock); (ii) the accruing of certain trade receivables and payables; and (iii)
the entering into or acquisition of any forward contract, futures contract,
option and similar financial instrument. However, regulated futures contracts
and non-equity options are generally not subject to the special currency rules
if they are or would be treated as sold for their fair market value at year-end
under the marking-to-market rules, unless an election is made to have such
currency rules apply. The disposition of a currency other than the U.S. dollar
by a U.S. taxpayer is also treated as a transaction subject to the special
currency rules. With respect to transactions covered by the special rules,
foreign currency gain or loss is calculated separately from any gain or loss on
the underlying transaction and is normally taxable as ordinary gain or loss. A
taxpayer may elect to treat as capital gain or loss foreign currency gain or
loss arising from certain identified forward contracts, futures contracts and
options that are capital assets in the hands of the taxpayer and which are not
part of a straddle. In accordance with Treasury regulations, certain
transactions subject to the special currency rules that are part of a "section
988 hedging transaction" (as defined in the Code and the Treasury regulations)
will be integrated and treated as a single transaction or otherwise treated
consistently for purposes of the Code. "Section 988 hedging transactions" are
not subject to the mark-to-market or loss deferral rules under the Code. It is
anticipated that some of the non-U.S. dollar denominated investments and foreign
currency contracts that such Funds may make or may enter into will be subject to
the special currency rules described above. Gain or loss attributable to the
foreign currency component of transactions engaged in by a Fund which are not
subject to special currency rules (such as foreign equity investments other than
certain preferred stocks) will be treated as capital gain or loss and will not
be segregated from the gain or loss on the underlying transaction.
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Qualification as a regulated investment company under the Code requires
that each Fund satisfy certain requirements with respect to the source of its
income during a taxable year. At least 90% of the gross income of each Fund
must be derived from dividends, interests, payments with respect to securities
loans, gains from the sale or other disposition of stock, securities or foreign
currencies, and other income (including but not limited to gains from options,
futures, or forward contracts) derived with respect to the Fund's business of
investing in such stock, securities or currencies. The Treasury Department may
by regulation exclude from qualifying income foreign currency gains which are
not directly related to a Fund's principal business of investing in stock or
securities, or options and futures with respect to stock or securities. Any
income derived by a Fund from a partnership or trust is treated as derived with
respect to the Fund's business of investing in stock, securities or currencies
only to the extent that such income is attributable to items of income which
would have been qualifying income if realized by the Fund in the same manner as
by the partnership or trust.
An additional requirement for qualification as a regulated investment
company under the Code is that less than 30% of a Fund's gross income must be
derived from gains realized on the sale or other disposition of the following
investments held for less than three moths: (1) stock and securities (as
defined in section 2(a)(36) of the Investment Company Act of 1940); (2) options,
futures and forward contracts other than those on foreign currencies; and (3)
foreign currencies (and options, futures and forward contracts on foreign
currencies) that are not directly related to a Fund's principal business of
investing in stock and securities (and options and futures with respect to
stocks and securities). With respect to futures contracts and other financial
instruments subject to the marking-to-market rules, the Internal Revenue Service
has ruled in private letter rulings that a gain realized from such a futures
contract or financial instrument will be treated as being derived from a
security held for three months or more (regardless of the actual period for
which the contract or instrument is held) if the gain arises as a result of a
constructive sale under the marking-to-market rules, and will be treated as
being derived from a security held for less than three months only if the
contract or instrument is terminated (or transferred) during the taxable year
(other than by reason of marking-to-market) and less than three months have
elapsed between the date the contract or instrument is acquired and the
termination date. In determining whether the 30% test is met for a taxable year,
increases and decreases in the value of each Fund's futures contracts and other
investments that qualify as part of a "designated hedge," as defined in the
Code, may be netted.
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PACIFIC HORIZON FUNDS, INC.
(THE "COMPANY")
PART B
STATEMENT OF ADDITIONAL INFORMATION
FOR
PACIFIC HORIZON CORPORATE BOND FUND
JULY 1, 1995
(AS REVISED MARCH 8, 1996)
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
THE COMPANY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
INVESTMENT OBJECTIVE AND POLICIES . . . . . . . . . . . . . . . . . . . . . 2
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION . . . . . . . . . . . . . . 22
ADDITIONAL INFORMATION CONCERNING TAXES . . . . . . . . . . . . . . . . . . 29
MANAGEMENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
GENERAL INFORMATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55
APPENDIX A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-1
APPENDIX B . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . B-1
</TABLE>
This Statement of Additional Information applies to the Pacific
Horizon Corporate Bond Fund (the "Fund") of the Company. This Statement of
Additional Information is meant to be read in conjunction with the Prospectus
dated July 1, 1995, as it may from time to time be revised (the "Prospectus"),
which describes the Fund. This Statement of Additional Information is
incorporated by reference in its entirety into the Prospectus. Because this
Statement of Additional Information is not itself a prospectus, no investment
in shares of the Fund should be made solely upon the information contained
herein. Copies of the Prospectus may be obtained by calling Concord Financial
Group, Inc. at 800-332-3863. Capitalized terms used but not defined herein
have the same meaning as in the Prospectus.
<PAGE> 224
THE COMPANY
The Company was organized on October 27, 1982 as a Maryland
corporation. The Fund originally commenced operations in 1973 as a
diversified, closed-end management investment company (that is, as an
investment company with non-redeemable shares) known as Bunker Hill Income
Securities, Inc. (the "Predecessor Fund"). On April 25, 1994 the Predecessor
Fund was reorganized as a separate portfolio of the Company and all of the
assets and liabilities of the Predecessor Fund were transferred to the Fund.
The Fund seeks to achieve its investment objective by investing substantially
all of its assets in a diversified investment portfolio of an open- end,
management investment company having the same investment objective as that of
the Fund.
Bank of America National Trust and Savings Association ("Bank of
America" or the "investment adviser") serves as investment adviser to the
Portfolio.
The Company also offers other investment portfolios which are
described in separate Prospectuses and Statements of Additional Information.
For information concerning these other portfolios contact the Distributor at
the telephone number stated on the cover page of this Statement of Additional
Information.
INVESTMENT OBJECTIVE AND POLICIES
The Prospectus for the Fund describes the investment objective of the
Fund and the Portfolio. Since the investment characteristics of the Fund will
correspond to those of the Portfolio, the following is a discussion of the
various investments of and techniques employed by the Portfolio. The following
information supplements and should be read in conjunction with the description
of the investment objective and policies for the Fund and the Portfolio in the
Prospectus for the Fund.
PORTFOLIO TRANSACTIONS
The portfolio turnover rate is calculated by dividing the lesser
of purchases or sales of portfolio securities for the year by the monthly
average value of the portfolio securities. The calculation excludes all
securities whose maturities at the time of acquisition were one year or less.
Portfolio turnover may vary greatly from year to year as well as within a
particular year, and may also be affected by cash requirements for redemptions
of shares and by requirements which enable the Company to receive certain
favorable tax treatment. Portfolio turnover will not be a limiting factor in
making portfolio decisions. For its fiscal year ended September 30, 1993, the
period from October 1, 1993 through April 24, 1994, the period April 25, 1994
(the date the Predecessor Fund was reorganized
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into the Fund) through September 30, 1994 and the period October 1, 1994 to
February 28, 1995, the portfolio turnover rates for the Predecessor Fund and
the Fund (as the case may be) were 154%, 15.7% (unannualized), N/A and N/A,
respectively. The portfolio turnover rate for the Portfolio was 51%
(unannualized) for the period from April 25, 1994 (commencement of operations)
through September 30, 1994 and 124% (unannualized) for the period from October
1, 1994 through February 28, 1995. The increase in portfolio turnover was
attributable to volatility in the market and good trading opportunities which
resulted in the increased opportunity to improve the relative value of the
Portfolio.
Subject to the general control of the Portfolio's Board of
Trustees, Bank of America is responsible for, makes decisions with respect to,
and places orders for, all purchases and sales of portfolio securities for the
Portfolio.
Transactions on stock exchanges involve the payment of negotiated
brokerage commissions. There is generally no stated commission in the case of
securities traded in the over-the-counter market, but the price includes an
undisclosed commission or mark-up. The cost of securities purchased by the
Portfolio from underwriters generally 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. Purchases and sales of
portfolio securities for the Predecessor Fund and the Portfolio are normally
principal transactions without brokerage commissions. During the three fiscal
years ended September 30, 1994 and the period October 1, 1994 to February 28,
1995, neither the Fund nor the Predecessor Fund paid any brokerage commissions.
In executing portfolio transactions and selecting brokers or
dealers, it is the Portfolio's policy to seek the best overall terms available.
The Investment Advisory Agreement between the Portfolio and Bank of America
provides that, in assessing the best overall terms available for any
transaction, Bank of America shall consider factors it deems 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, for the specific transaction and
on a continuing basis. In addition, the Investment Advisory Agreement
authorizes Bank of America subject to the approval of the Board of Trustees of
the Portfolio to cause the Portfolio to pay a broker-dealer which furnishes
brokerage and research services a higher commission than that which might be
charged by another broker-dealer for effecting the same transaction, provided
that such commission is deemed reasonable in terms of either that particular
transaction or the overall responsibilities of Bank of America to the Fund,
Company or Portfolio. Brokerage and research services may include: (1) advice
as to the value of securities, the
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advisability of investing in, purchasing or selling securities and the
availability of securities or purchasers or sellers of securities; and (2)
analyses and reports concerning industries, securities, economic factors and
trends, portfolio strategy and the performance of accounts.
It is possible that certain of the brokerage and research services
received will primarily benefit one or more other investment companies or other
accounts for which investment discretion is exercised. Conversely, the
Portfolio may be the primary beneficiary of the brokerage or research services
received as a result of portfolio transactions effected for such other accounts
or investment companies.
Brokerage and research services so received are in addition to and
not in lieu of services required to be performed by Bank of America and do not
reduce the advisory fee payable to Bank of America. Such services may be
useful to Bank of America in serving both the Company, the Portfolio and other
clients and, conversely, services obtained by the placement of business of
other clients may be useful to Bank of America in carrying out its obligations
to the Company and the Portfolio. In connection with its investment management
services with respect to the Portfolio, Bank of America will not acquire
certificates of deposit or other securities issued by it or its affiliates, and
will give no preference to certificates of deposit or other securities issued
by Service Organizations. In addition, portfolio securities in general will be
purchased from and sold to affiliates of the Company, the Portfolio, Bank of
America, the Distributor and their affiliates acting as principal underwriter,
syndicate member, market-maker, dealer, broker or in any similar capacity,
provided such purchase, sale or dealing is permitted under the Investment
Company Act of 1940 (the "1940 Act") and the rules thereunder.
The Portfolio may participate, if and when practicable, in bidding
for the purchase of securities of the U.S. Government and its agencies and
instrumentalities directly from an issuer in order to take advantage of the
lower purchase price available to members of a bidding group. The Portfolio
will engage in this practice only when Bank of America, in its sole discretion,
subject to guidelines adopted by the Board of Trustees of the Portfolio,
believes such practice to be in the interest of the Portfolio.
To the extent permitted by law, Bank of America may aggregate the
securities to be sold or purchased on behalf of the Portfolio with those to be
sold or purchased for other investment companies or common trust funds in order
to obtain best execution.
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The Company is required to identify any securities of its regular
brokers or dealers (as defined in Rule 10b-1 under the 1940 Act or their
parents held by the Company as of the close of its most recent fiscal year. As
of February 28, 1995: (a) the Treasury Fund held the following securities,
Repurchase Agreement with Goldman, Sachs & Co. in the principal amount of
$95,000,000; Repurchase Agreement with Merrill Lynch Government Securities,
Inc. in the principal amount of $95,000,000; (b) the Prime Fund held the
following securities, Merrill Lynch & Co., Inc., commercial paper in the
principal amount of $l00,000,000; Goldman, Sachs Group L.P., Daily Variable
Rate Master Note in the principal amount of $120,000,000; Morgan Stanley Group,
Inc., Daily Variable Rate Master Note in the principal amount of $120,000,000;
Bear Stearns Co., Inc., Series B, Monthly Variable Rate Note in the principal
amount of $100,000,000; Repurchase Agreement with Goldman, Sachs & Co. in the
principal amount of $120,000,000; (c) the Government Fund held the following
securities, Repurchase Agreement with Goldman, Sachs & Co. in the principal
amount of $40,000,000; Repurchase Agreement with Merrill Lynch Government
Securities, Inc. in the principal amount of $40,000,000; and (d) the Prime
Value Fund held the following securities, Merrill Lynch & Co., Inc., commercial
paper in the principal amount of $7,000,000; Goldman, Sachs Group L.P., Daily
Variable Rate Master Note in the principal amount of $7,000,000; Repurchase
Agreement with Dean Witter Reynolds, Inc. in the principal amount of
$8,000,000; Repurchase Agreement with Goldman, Sachs & Co. in the principal
amount of $8,000,000.
Merrill Lynch & Co., Inc., Goldman Sachs & Co., Bear Stearns Co.,
Inc., Morgan Stanley & Co. Incorporated, Shearson Lehman Brothers, Inc., Dean
Witter Reynolds, Inc. and Paine Webber are considered to be regular brokers and
dealers of the Company.
TYPES OF OBLIGATIONS, INVESTMENT RISKS, AND OTHER INVESTMENT INFORMATION
The following discussion supplements the description of such
investments in the Prospectus.
Bank Certificates of Deposit, Bankers' Acceptances and
Interest-Bearing Savings Deposits. Certificates of deposit, bankers'
acceptances and interest-bearing savings deposits are eligible investments for
the Portfolio as described in the Fund's Prospectus. 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
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maturity. Interest-bearing savings deposits are non-negotiable deposits
maintained at a banking institution for a specified period of time at a
specified interest rate.
Commercial Paper. The investment policies of the Portfolio permit
investment in commercial paper. Commercial paper consists of unsecured
promissory notes issued by corporations. Issues of commercial paper will
normally have maturities of less than nine months and fixed rates of return,
although such instruments may have maturities of up to one year.
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 for the Portfolio, the
investment adviser will consider, among other factors, its 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 stocks; the prices of the securities relative
to other comparable securities and to the underlying stocks; whether the
securities are entitled to the benefits of sinking funds or other protective
conditions; diversification of the Portfolio as to issuers; and whether the
securities are rated by Moody's Investors Service, Inc. ("Moody's") or Standard
& Poor's Ratings Group, Division of McGraw Hill ("S&P") 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 stock). The investment value of convertible
securities is influenced by changes in interest rates, with investment value
declining as interest rates increases 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 stock. If the conversion value is low relative to the
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investment value, the price of the convertible securities is governed
principally by their investment value. To the extent the market price of the
underlying 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 stock while holding fixed income
securities.
Repurchase Agreements. The Portfolio is permitted to enter into
repurchase agreements with respect to its portfolio securities. Pursuant to
such agreements, the Portfolio acquires securities from financial institutions
such as banks and broker-dealers as are deemed to be creditworthy subject to
the seller's agreement to repurchase and the agreement of the Portfolio to
resell such securities at a mutually agreed upon date and price. Although
securities subject to a repurchase agreement may bear maturities exceeding ten
years, the Portfolio intends to only enter into repurchase agreements having
maturities not exceeding 60 days. The Portfolio is not permitted to enter into
repurchase agreements with Bank of America or its affiliates, and will give no
preference to repurchase agreements with Service Organizations. The repurchase
price generally equals the price paid by the Portfolio plus interest negotiated
on the basis of current short-term rates (which may be more or less than the
rate on the underlying portfolio security). Securities subject to repurchase
agreements will be held by a custodian or sub-custodian of the Portfolio or in
the Federal Reserve/Treasury Book-Entry System. The seller under a repurchase
agreement will be required to deliver instruments the value of which is 102% of
the repurchase price (excluding accrued interest), provided that
notwithstanding such requirement, the advisor shall require that the value of
the collateral, after transaction costs (including loss of interest) reasonably
expected to be incurred on a default, shall be equal to or greater than the
resale price (including interest) provided in the agreement. If the seller
defaulted on its repurchase obligation, the Portfolio would suffer a loss
because of adverse market action or to the extent that the proceeds from a sale
of the underlying securities were less than the repurchase price under the
agreement. Bankruptcy or insolvency of such a defaulting seller may cause the
Portfolio's rights with respect to such securities to be delayed or limited.
Repurchase agreements are considered to be loans by the Portfolio under the
1940 Act.
U.S. Government Obligations. The Portfolio is permitted to make
investments in U.S. Government obligations. Such obligations include Treasury
bills, certificates of indebtedness, notes and bonds, and issues of such
entities as the Government National Mortgage Association, Export-Import Bank of
the United States, Tennessee Valley Authority, Resolution Funding
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Corporation, Farmers Home Administration, Federal Home Loan Banks, Federal
Intermediate Credit Banks, Federal Farm Credit Banks, Federal Land Banks,
Federal Housing Administration, Federal National Mortgage Association, Federal
Home Loan Mortgage Corporation, and the Student Loan Marketing Association.
Treasury bills have maturities of one year or less, Treasury notes have
maturities of one to ten years and Treasury bonds generally have maturities of
more than ten years. Some of these obligations, such as those of the
Governmental National Mortgage Association, are supported by the full faith and
credit of the U.S. Treasury; others, such as those of the Export-Import Bank of
the United States, are supported by the right of the issuer to borrow from the
Treasury; others, such as those of the Federal National Mortgage Association,
are supported by the discretionary authority of the U.S. Government to purchase
the agency's obligations; still others, such as those of the Student Loan
Marketing Association, are supported only by the credit of the instrumentality.
No assurance can be given that the U.S. Government would provide financial
support to U.S. Government sponsored instrumentalities if it is not obligated
to do so by law.
Asset-Backed Securities. The Portfolio may invest in asset-backed
securities, including mortgage-backed securities representing an undivided
ownership interest in a pool of mortgages, such as certificates of the
Government National Mortgage Association ("GNMA") and the Federal Home Loan
Mortgage Corporation ("FHLMC"). These certificates are in most cases
pass-through instruments, through which the holder receives a share of all
interest and principal payments from the mortgages underlying the certificate,
net of certain fees. The average life of a mortgage-backed security varies
with the underlying mortgage instruments, which have maximum maturities of 40
years. The average life is likely to be substantially less than the original
maturity of the mortgage pools underlying the securities as the result of
prepayments, mortgage refinancings or foreclosure. Mortgage prepayment rates
are affected by factors including the level of interest rates, general economic
conditions, the location and age of the mortgage and other social and
demographic conditions. Such prepayments are passed through to the registered
holder with the regular monthly payments of principal and interest and have the
effect of reducing future payments.
The Portfolio may also invest in non-mortgage backed securities
including interests in pools of receivables, such as motor vehicle installment
purchase obligations and credit card receivables. Such securities are
generally issued as pass-through certificates, which represent undivided
fractional ownership interests in the underlying pools of assets. Such
securities may also be debt instruments, which are also known as collateralized
obligations and are generally issued as the debt
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of a special purpose entity organized solely for the purpose of owning such
assets and issuing such debt. Non-mortgage backed securities are not issued or
guaranteed by the U.S. Government or its agencies or instrumentalities;
however, the payment of principal and interest on such obligations may be
guaranteed up to certain amounts and for a certain time period by a letter of
credit issued by a financial institution (such as a bank or insurance company)
unaffiliated with the issuers of such securities.
The purchase of non-mortgage backed securities raises
considerations peculiar to the financing of the instruments underlying such
securities. For example, most organizations that issue asset-backed securities
relating to motor vehicle installment purchase obligations perfect their
interests in the respective obligations only by filing a financing statement
and by having the servicer of the obligations, which is usually the originator,
take custody thereof. In such circumstances, if the servicer were to sell the
same obligations to another party, in violation of its duty not to do so, there
is a risk that such party could acquire an interest in the obligations superior
to that of the holders of the asset-backed securities. Also, although most of
the obligations grant a security interest in the motor vehicle being financed,
in most states the security interest in a motor vehicle must be noted on the
certificate of title to perfect such security interest against competing claims
of other parties. Due to the large number of vehicles involved, however, the
certificate of title to each vehicle financed, pursuant to the obligations
underlying the asset-backed securities, usually is not amended to reflect the
assignment of the seller's security interest for the benefit of the holders of
the asset-backed securities. Therefore, there is the possibility that
recoveries on repossessed collateral may not, in some cases, be available to
support payments on those securities. In addition, various state and federal
laws give the motor vehicle owner the right to assert against the holder of the
owner's obligation certain defenses such owner would have against the seller of
the motor vehicle. The assertion of such defenses could reduce payments on the
related asset-backed securities. Insofar as credit card receivables are
concerned, credit card holders are entitled to the protection of a number of
state and federal consumer credit laws, many of which give such holders the
right to set off certain amounts against balances owed on the credit card,
thereby reducing the amounts paid on such receivables. In addition, unlike
most other asset-backed securities, credit card receivables are unsecured
obligations of the cardholder.
The development of non-mortgage backed securities is at an early
stage compared to mortgage backed securities. While the market for
asset-backed securities is becoming increasingly liquid, the market for
mortgage backed securities issued by
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certain private organizations and non-mortgage backed securities is not as well
developed as that for mortgage backed securities guaranteed by government
agencies or instrumentalities. Bank of America intends to limit its purchases
of mortgage backed securities issued by certain private organizations and
non-mortgage backed securities to securities that are readily marketable at the
time of purchase.
Variable and Floating Rate Instruments. The Portfolio may acquire
variable and floating rate instruments. Such instruments are frequently not
rated by credit rating agencies. However, in determining the creditworthiness
of unrated variable and floating rate instruments and their eligibility for
purchase by the Portfolio, Bank of America will consider the earning power,
cash flow and other liquidity ratios of the issuers of such instruments (which
include financial, merchandising, bank holding and other companies) and will
continuously monitor their financial condition. An active secondary market may
not exist with respect to particular variable or floating rate instruments
purchased by the Portfolio. The absence of such an active secondary market
could make it difficult to dispose of a variable or floating rate instrument in
the event the issuer of the instrument defaulted on its payment obligation or
during periods that the Portfolio is not entitled to exercise its demand
rights, and the Portfolio could, for these or other reasons, suffer a loss to
the extent of the default. Investments in illiquid variable and floating rate
instruments (instruments which are not payable upon seven days' notice and do
not have active trading markets) are subject to the Portfolio's 15% limitation
on illiquid securities. Variable and floating rate instruments may be secured
by bank letters of credit.
Reverse Repurchase Agreements. As described in the Prospectus,
the Portfolio is permitted to borrow funds for temporary purposes by entering
into reverse repurchase agreements with such financial institutions as banks and
broker-dealers in accordance with the investment limitations described therein.
Reverse repurchase agreements are considered to be borrowings by the Portfolio
under the 1940 Act. Whenever the Portfolio enters into a reverse repurchase
agreement, it will place in a segregated account maintained with its custodian
liquid assets such as cash, U.S. Government securities or other liquid high
grade debt securities having a value equal to the repurchase price (including
accrued interest) and Bank of America will subsequently continuously monitor the
account for maintenance of such equivalent value. The Portfolio intends to
enter into reverse repurchase agreements to avoid otherwise having to sell
securities during unfavorable market conditions in order to meet redemptions.
Reverse repurchase agreements are considered to be borrowings by the Portfolio
under the 1940 Act.
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Writing Covered Options. The Portfolio may write (sell) covered
call and put options on any securities in which it may invest. All call
options written by the Portfolio are covered; the Portfolio may cover a call
option by owning the securities subject to the option so long as the option is
outstanding or using the other methods described below. The purpose of writing
covered call options is to realize greater income than would be realized on
portfolio securities transactions alone. However, in writing covered call
options for additional income, the Portfolio may forego the opportunity to
profit from an increase in the market price of the underlying security.
All put options written by the Portfolio would be covered; the
Portfolio may cover a put option by depositing with its custodian cash, U.S.
Government securities or other liquid high-grade debt securities (i.e.,
securities rated in one of the top three categories by Moody's or S&P, or, if
unrated, deemed by Bank of America to be of comparable credit quality) with a
value at least equal to the exercise price of the put option or using the other
methods described below. The purpose of writing such options is to generate
additional income for the Portfolio. However, in return for the option
premium, the Portfolio accepts the risk that it may be required to purchase the
underlying securities at a price in excess of the securities' market value at
the time of purchase.
In addition, a written call option or put option may be covered by
maintaining cash or high grade liquid debt securities (either of which may be
denominated in any currency) in a segregated account, by entering into an
offsetting forward contract and/or by purchasing an offsetting option or any
other option on the same or a related currency and/or by purchasing an
offsetting option or any other option which, by virtue of its exercise price or
otherwise, reduces the Portfolio's net exposure on its written option position.
The Portfolio may also write (sell) covered call and put options
on any securities index composed of securities in which it may invest. Options
on securities indices are similar to options on securities, except that the
exercise of securities index options requires cash payments and does not involve
the actual purchase or sale of securities. In addition, securities index
options are designed to reflect price fluctuations in a group of securities or
segment of the securities market rather than price fluctuations in a single
security.
The Portfolio may cover call options on a securities index by
owning securities whose price changes are expected to be similar to those of
the underlying index, or by having an absolute and immediate right to acquire
such securities without additional cash consideration (or for additional cash
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consideration held in a segregated account by its custodian) upon conversion or
exchange of other securities in its portfolio. The Portfolio may cover call
and put options on a securities index by maintaining cash or liquid high grade
debt securities with a value equal to the exercise price in a segregated
account with its custodian or by using the other methods described above.
The Portfolio may terminate its obligations under a written call
or put option by purchasing an option identical to the one it has written. Such
purchases are referred to as "closing purchase transactions."
Purchasing Options. The Portfolio may purchase put and call
options on any securities in which it may invest. The Portfolio would also be
able to enter into closing sale transactions in order to realize gains or
minimize losses on options it has purchased.
The Portfolio would normally purchase call options in anticipation
of an increase in the market value of securities of the type in which it may
invest. The purchase of a call option would entitle the Portfolio, in return
for the premium paid, to purchase specified securities at a specified price
during the option period. The Portfolio would ordinarily realize a gain if,
during the option period, the value of such securities exceeded the sum of the
exercise price, the premium paid and transaction costs. Otherwise the
Portfolios would realize either no gain or a loss on the purchase of the call
option.
The Portfolio would normally purchase put options in anticipation
of a decline in the market value of securities in its portfolio ("protective
puts") or in securities in which it may invest. The purchase of a put option
would entitle the Portfolio, in exchange for the premium paid, to sell
specified securities at a specified price during the option period. The
purchase of protective puts is designed to offset or hedge against a decline in
the market value of the Portfolio's securities. Put options may also be
purchased by the Portfolio for the purpose of affirmatively benefiting from a
decline in the price of securities which it does not own. The Portfolio would
ordinarily realize a gain if, during the option period, the value of the
underlying securities decreased below the exercise price sufficiently to more
than cover the premium and transaction costs. Otherwise the Portfolio would
realize either no gain or a loss on the purchase of the put option. Gains and
losses on the purchase of protective put options would tend to be offset by
countervailing changes in the value of underlying portfolio securities.
Transactions by the Portfolio in options on securities will be
subject to limitations established by each of the exchanges, boards of trade or
other trading facilities governing
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the maximum number of options in each class which may be written or purchased
by a single investor or group of investors acting in concert, regardless of
whether the options are written or purchased on the same or different
exchanges, board of trade or other trading facilities or are held or written in
one or more accounts or through one or more brokers. Thus, the number of
options which the Portfolio may write or purchase may be affected by options
written or purchased by other investment advisory clients of Bank of America.
An exchange, board of trade or other trading facility may order the liquidation
of positions found to be in excess of these limits, and it may impose certain
other sanctions.
Risks Associated with Options Transactions. There is no assurance
that a liquid secondary market on a domestic or foreign options exchange will
exist for any particular exchange-traded option or at any particular time.
Reasons for the absence of a liquid secondary market on an exchange include the
following: (i) there may be insufficient trading interest in certain options;
(ii) restrictions may be imposed by an exchange on opening transactions or
closing transactions or both; (iii) trading halts, suspensions or other
restrictions may be imposed with respect to particular classes or series of
options; (iv) unusual or unforeseen circumstances may interrupt normal
operations on an exchange; (v) the facilities of an exchange or the Options
Clearing Corporation may not at all times be adequate to handle current trading
volume; or (vi) 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 on that exchange that had been issued by the
Options Clearing Corporation as result of trades on that exchange would continue
to be exercisable in accordance with their terms.
The Portfolio may purchase and sell both options that are traded
on United States and foreign exchanges and options traded over-the-counter with
broker-dealers who make markets in these options. The ability to terminate
over-the-counter options is more limited than with exchange-traded options and
may involve the risk that broker-dealers participating in such transactions will
not fulfill their obligations.
Futures Contracts and Options on Futures Contracts. The Portfolio
may engage in futures and related options transactions only for hedging purposes
as defined below or for non-hedging purposes to the extent permitted by
regulations of the Commodities Futures Trading Commission ("CFTC"). All futures
contracts entered into by the Portfolio would be traded on U.S. exchanges or
boards of trade that are licensed and regulated by the CFTC or on foreign
exchanges.
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Futures Contracts. A futures contract may generally be described
as an agreement between two parties to buy and sell particular financial
instruments for an agreed price during a designated month (or to deliver the
final cash settlement price, in the case of a contract relating to an index or
otherwise not calling for physical delivery at the end of trading in the
contract).
When interest rates are rising or securities prices are falling,
the Portfolio can seek through the sale of futures contracts to offset a
decline in the value of its current portfolio securities. When rates are
falling or prices are rising, the Portfolio, through the purchase of futures
contracts, can attempt to secure better rates or prices than might later be
available in the market when it effects anticipated purchases.
Positions taken in the futures markets are not normally held to
maturity, but are instead liquidated through offsetting transactions which may
result in a profit or a loss. While the Portfolio's futures contracts on
securities will usually be liquidated in this manner, it may instead make or
take delivery of the underlying securities whenever it appears economically
advantageous for the Portfolio to do so. A clearing corporation associated
with the exchange on which futures on securities are traded guarantees that, if
still open, the sale or purchase will be performed on the settlement date.
Hedging Strategies. Hedging by use of futures contracts seeks to
establish more certainty than would otherwise be possible with respect to the
effective price rate or rate of return on portfolio securities or securities
that the Portfolio owns or proposed to acquire. The Portfolio may, for
example, take a "short" position in the futures market by selling futures
contracts in order to hedge against an anticipated rise in interest rates or a
decline in market prices that would adversely affect the dollar value of the
Portfolio's securities. Such futures contracts may include contracts for the
future delivery of securities held by the Portfolio or securities with
characteristics similar to those of the Portfolio's securities. If, in the
opinion of Bank of America, there is a sufficient degree of correlation between
price trends for the Portfolio's securities and futures contracts based on
other financial instruments, securities indices or other indices, the Portfolio
may also enter into such futures contracts as part of its hedging strategy.
Although under some circumstances prices of securities in the Portfolio's may
be more or less volatile than prices of such futures contract, Bank of America
will attempt to estimate the extent of this difference in volatility based on
historical patterns and to compensate for it by having the Portfolio enter into
a greater or lesser number of futures contracts or by attempting to achieve
only a partial hedge against price changes affecting the Portfolio's
securities. When hedging of this
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character is successful, any depreciation in the value of portfolio securities
will substantially be offset by appreciation in the value of the futures
position. On the other hand, any unanticipated appreciation in the value of
the Portfolio's securities would be substantially offset by a decline in the
value of the futures position.
On other occasions, the Portfolio may take a "long" position by
purchasing such futures contracts. This would be done, for example, when the
Portfolio anticipates the subsequent purchase of particular securities when it
has the necessary cash, but expects the prices then available in the applicable
market to be less favorable than prices that are currently available.
Options on Futures Contracts. The acquisition of put and call
options on futures contracts will give the Portfolio the right (but not the
obligation), for a specified price, to sell or to purchase, respectively, the
underlying futures contract at any time during the option period. As the
purchaser of an option on a futures contract, the Portfolio obtains the benefit
of the futures position if prices move in a favorable direction but limits its
risk of loss in the event of an unfavorable price movement to the loss of the
premium and transaction costs.
The writing of a call option on a futures contract generates a
premium which may partially offset a decline in the value of the Portfolio's
assets. By writing a call option, the Portfolio becomes obligated, in exchange
for the premium, to sell a futures contract, which may have a value higher than
the exercise price. Conversely, the writing of a put option on a futures
contact generates a premium, which may partially offset an increase in the
price of securities that the Portfolio intends to purchase. However, the
Portfolio becomes obligated to purchase a futures contract, which may have a
value lower than the exercise price. Thus, the loss incurred by the Portfolio
in writing options on futures is potentially unlimited and may exceed the
amount of the premium received. The Portfolio will incur transaction costs in
connection with the writing of options on futures.
The holder or writer of an option on a futures contract may
terminate its position by selling or purchasing an offsetting option on the
same series. There is no guarantee that such closing transactions can be
effected. The Portfolio's ability to establish and close out positions on such
options will be subject to the development and maintenance of a liquid market.
Other Considerations. The Portfolio will engage in futures and
related options transactions only for hedging or non- hedging purposes in
accordance with CFTC regulations which permit principals of an investment
company registered under the 1940 Act to engage in such transactions without
registering as commodity
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pool operators. The Portfolio would determine that the price fluctuations in
the futures contracts and options on futures used for hedging purposes are
substantially related to price fluctuations in securities held by the Portfolio
or which it expects to purchase. Except as stated below, any futures
transactions would be entered into for traditional hedging purposes -- i.e.,
futures contracts would be sold to protect against a decline in the price of
securities that the Portfolio owned, or futures contracts would be purchased to
protect the Portfolio against an increase in the price of securities it
intended to purchase. As evidence of this hedging intent, the Portfolio
expects that on 75% or more of the occasions on which it takes a long futures
(or option) position (involving the purchase of futures contracts), the
Portfolio will have purchased, or will be in the process of purchasing,
equivalent amounts of related securities in the cash market at the time when
the futures (or option) position is closed out. However, in particular cases,
when it is deemed economically advantageous for the Portfolio to do so, a long
futures position may be terminated (or an option may expire) without the
corresponding purchase of securities.
As an alternative to literal compliance with the bona fide hedging
definition, a CFTC regulation permits the Portfolio to elect to comply with a
different test, under which the aggregate initial margin and premiums required
to establish non-hedging positions in futures contracts and options on futures
will not exceed 5 percent of the value of the net assets of the Portfolio,
after taking into account unrealized profits and losses on any such positions
and excluding the amount by which such options were in-the-money at the time of
purchase.
Transactions in futures contracts and options on futures involve
brokerage costs, require margin deposits and, in the case of contracts and
options obligating the Portfolio to purchase securities, require the Portfolio
to segregate, with its custodian, liquid high grade debt securities in an
amount equal to the underlying value of such contracts and options.
While transactions in futures contracts and options on futures may
reduce certain risks, such transactions themselves entail certain other risks.
Thus, while the Portfolio may benefit from the use of futures and options on
futures, unanticipated changes in interest rates or securities prices may result
in a poorer overall performance for the Portfolio than if it had not entered
into any futures contracts or options transactions. In the event of an
imperfect correlation between a futures position and a portfolio position which
is intended to be protected, the desired protection may not be obtained and the
Portfolio may be exposed to risk of loss.
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Perfect correlation between the Portfolio's futures positions and
portfolio positions may be difficult to achieve because no futures contracts
based on corporate fixed-income securities are currently available.
Interest Rate and Currency Swaps. Inasmuch as interest rate and
currency swaps are entered into for hedging purposes or are offset by a
segregated account as described below, the Portfolio and Bank of America
believe that swaps do not constitute senior securities as defined in the Act
and, accordingly, will not treat them as being subject to the Portfolio's
borrowing restrictions. The net amount of the excess, if any, of the
Portfolio's obligations over its entitlements with respect to each interest
rate or currency swap will be accrued on a daily basis and an amount of cash or
liquid high grade debt securities (i.e., securities rated in one of the top
three ratings categories by Moody's or Standard & Poor's, or, if unrated,
deemed by Bank of America to be of comparable credit quality, having an
aggregate net asset value at least equal to such accrued excess will be
maintained in a segregated account by the Portfolio's custodian. The Portfolio
will not enter into any interest rate or currency swap unless the credit
quality of the unsecured senior debt or the claims-paying ability of the other
party thereto is considered to be investment grade by Bank of America. If
there were a default by the other party to such a transaction, the Portfolio
would 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 the markets for other
similar instruments which are traded in the interbank market.
Foreign Investments. In determining whether to invest in the
securities of foreign issuers, Bank of America will consider such factors as
the characteristics of the particular issuer, differences between economic
trends and the performance of securities markets within the U.S. and those
within other countries, and also factors relating to the general economic,
governmental and social conditions of the country or countries where the issuer
is located. The extent to which the Portfolio will be invested in foreign
issuers will fluctuate from time to time depending on Bank of America's
assessment of prevailing market, economic and other conditions.
Bonds of Supranational Entities. The Portfolio may invest in
bonds of supranational entities. A supranational entity is an entity
established or financially supported by the national governments of one or more
countries to promote reconstruction or development. Examples of supranational
entities include, among others, the World Bank, the European
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Economic Community, the European Coal and Steel Community, the European
Investment Bank, the Inter-American Development Bank, the Export-Import Bank
and the Asian Development Bank.
When-Issued Securities, Forward Commitments and Delayed
Settlements. When the Portfolio agrees to purchase securities on a
"when-issued," forward commitment or delayed settlement basis, its custodian
will set aside cash or liquid portfolio securities equal to the amount of the
commitment in a separate account. Normally, the custodian will set aside
portfolio securities to satisfy a purchase commitment. In such a case, the
Portfolio may be required subsequently to place additional assets in the
separate account in order to assure that the value of the account remains equal
to the amount of the commitment. It may be expected that the net assets of the
Portfolio will fluctuate to a greater degree when it sets aside portfolio
securities to cover such purchase commitments than when it sets aside cash.
The Portfolio does not intend to engage in these transactions for speculative
purposes but only in furtherance of its investment objective. Because the
Portfolio will set aside cash or liquid portfolio securities to satisfy its
purchase commitments in the manner described, its liquidity and the ability of
the investment adviser to manage it may be affected in the event the forward
commitments, commitments to purchase when-issued securities and delayed
settlements ever exceeded 25% of the value of the Portfolio's assets.
The Portfolio will purchase securities on a when-issued, forward
commitment or delayed settlement basis only with the intention of completing
the transaction. If deemed advisable as a matter of investment strategy,
however, the Portfolio may dispose of or renegotiate a commitment after it is
entered into, and may sell securities it has committed to purchase before those
securities are delivered to the Portfolio on the settlement date. In these
cases the Portfolio may realize a taxable capital gain or loss.
When the Portfolio engages in when-issued, forward commitment and
delayed settlement transactions, it relies on the other party to consummate the
trade. Failure of such party to do so may result in the Portfolio's incurring
a loss or missing an opportunity to obtain a price considered to be
advantageous.
The market value of the securities underlying a when-issued
purchase, forward commitment to purchase securities, or a delayed settlement
and any subsequent fluctuations in their market value is taken into account
when determining the market value of the Portfolio starting on the day the
Portfolio agrees to purchase the securities. The Portfolio does not earn
interest on the securities it has committed to purchase until they are paid for
and delivered on the settlement date.
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Securities Lending. The Portfolio may lend securities as
described in its Prospectus. Such loans will be secured by cash or securities
of the U.S. Government and its agencies and instrumentalities. The collateral
must be at all times equal to at least the market value of the securities
loaned. The Portfolio will continue to receive interest or dividends on the
securities it loans, and will also earn interest on the investment of any cash
collateral. Cash collateral may be invested in short-term U.S. Government
securities, U.S. Treasury notes, certificates of deposit, other high-grade,
short-term obligations or interest-bearing cash equivalents. Although voting
rights, or rights to consent, attendant to securities loaned pass to the
borrower, such loans may be called at any time and will be called so that the
securities may be voted by the Portfolio if a material event affecting the
investment is to occur.
Illiquid Securities. It is possible that unregistered securities
purchased by the Portfolio in reliance upon rule 144A under the Securities Act
of 1933 could have the effect of increasing the level of the Portfolio's, and
correspondingly the Fund's, illiquidity to the extent that qualified
institutional buyers become, for a period, uninterested in purchasing these
securities.
OTHER INVESTMENT LIMITATIONS
The investment objectives of the Fund and the Portfolio are
fundamental; the Prospectus for the Fund sets forth or summarizes certain other
fundamental policies that may not be changed with respect to the Fund or the
Portfolio without the affirmative vote of the holders of the majority of the
Fund's outstanding shares or the Portfolio's outstanding interests (as defined
below under "General Information - Miscellaneous"). The following is a list of
additional fundamental policies which may not be changed with respect to the
Fund or the Portfolio without such a vote.
NEITHER THE FUND NOR THE PORTFOLIO MAY:
1. Purchase securities (except securities issued by the U.S.
Government, its agencies or instrumentalities) if, as a result more than 5% of
its total assets will be invested in the securities of any one issuer, except
that up to 25% of its total assets may be invested without regard to this 5%
limitation; provided that all of the assets of the Fund may be invested in the
Portfolio or another investment company.
2. Underwrite the securities of other issuers, provided that
all of the assets of the Fund may be invested in the Portfolio or another
investment company.
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3. Purchase or sell real estate, except that the Portfolio
may, to the extent appropriate to its investment objective, invest in securities
and instruments guaranteed by agencies or instrumentalities of the U.S.
Government and securities issued by companies which invest in real estate or
interests therein.
4. Purchase securities on margin (except for such short-term
credits as may be necessary for the clearance of transactions), make short sales
of securities or maintain a short position. For this purpose, the deposit or
payment by the Portfolio for initial or maintenance margin in connection with
futures contracts is not considered to be the purchase or sale of a security on
margin.
5. Write or sell puts, calls, straddles, spreads or
combinations thereof, except that it may engage in options transactions.
6. Purchase or sell commodities or commodity contracts, or
invest in oil, gas or mineral exploration or development programs, except that:
(a) it may, to the extent appropriate to its investment objective, invest in
securities issued by companies which purchase or sell commodities or commodity
contracts or which invest in such programs; and (b) it may purchase and sell
futures contracts and options on futures contracts.
7. Purchase securities of other investment companies, except
(a) in connection with a merger, consolidation, acquisition or reorganization;
(b) as may otherwise be permitted by the 1940 Act; provided that all of the
assets of the Fund may be invested in the Portfolio or another investment
company.
8. Purchase any securities which would cause 25% or more of
the value of its total assets at the time of such purchase to be invested in the
securities of one or more issuers conducting their principal business activities
in the same industry; provided, however, that (a) there is no limitation with
respect to investments in obligations issued or guaranteed by the federal
government and its agencies and instrumentalities; (b) each utility (such as
gas, gas transmission, electric and telephone service) will be considered a
single industry for purposes of this policy; and (c) wholly-owned finance
companies will be considered to be in the industries of their parents if their
activities are primarily related to financing the activities of their parents.
9. Purchase securities of any issuer if as a result it would
own more than 10% of the voting securities of such issuer; provided that all of
the assets of the Fund may be invested in the Portfolio or another investment
company.
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<PAGE> 243
10. Borrow money for the purpose of obtaining investment
leverage or issue senior securities (as defined in the 1940 Act), provided that
the Fund and the Portfolio may borrow from banks for temporary purposes and in
an amount not exceeding 10% of the value of the total assets of the Fund or the
Portfolio; or mortgage, pledge or hypothecate any assets, except in connection
with any such borrowing and in amounts not in excess of the lesser of the
dollar amounts borrowed or 10% of the value of its total assets at the time of
such borrowing. This restriction shall not apply to (a) the sale of portfolio
securities accompanied by a simultaneous agreement as to their repurchase, or
(b) transactions in currency, options, futures contracts and options on futures
contracts, or forward commitment transactions.
11. Make loans, except that it may purchase or hold debt
obligations in accordance with its investment objective, policies and
limitations; may enter into repurchase agreements with respect to securities;
and may lend portfolio securities against collateral consisting of cash or
securities of the U.S. Government and its agencies and instrumentalities which
are consistent with its permitted investments.
* * *
If a percentage restriction is satisfied at the time of
investment, a later increase or decrease in such percentage resulting from a
change in asset value will not constitute a violation of such restriction.
For the purposes of Investment Limitation 8 above, the Portfolio
and Fund treat, in accordance with the current views of the staff of the
Securities and Exchange Commission (the "SEC") and as a matter of
non-fundamental policy that may be changed without a vote of shareholders, all
supranational organizations as a single industry and each foreign government
(and all of its agencies) as a separate industry.
In order to permit the sale of the Fund's shares in certain
states, the Company may make commitments more restrictive than the investment
policies and limitations described above. As of the date of this Statement of
Additional Information, the following such commitments have been made: 1) that
the Fund will not purchase or retain the securities of any issuer if the
officers or directors or trustees of the Company, its advisors or managers of
the Fund, owning beneficially more than one half of one percent of the
securities of an issuer together own beneficially more than five percent of the
securities of that issuer; and 2) that the Fund will not invest more than 15% of
its total assets in the securities of issuers which together with any
predecessors have a record of less than three years continuous
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<PAGE> 244
operation or securities of issuers which are restricted as to disposition.
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION
Information on how to purchase and redeem Fund shares, and how
such shares are priced, is included in the Prospectus. The net asset value per
share of the Portfolio is determined at the same time and on the same days as
the net asset value per share of the Fund is determined. The net asset value of
the Fund is equal to the Fund's pro rata share of the total investments and
other assets of the Portfolio, less any liabilities with respect to the Fund,
including the Fund's pro rata share of the Portfolio's liabilities.
Portfolio securities for which market quotations are readily
available (other than debt securities with remaining maturities of 60 days or
less) are valued at the last reported sale price or (if none is available) the
mean between the current quoted bid and asked prices provided by investment
dealers. Other securities and assets for which market quotations are not
readily available are valued at their fair value using methods determined under
the supervision of the Board of Trustees of the Portfolio. Debt securities
with remaining maturities of 60 days or less are valued on an amortized cost
basis unless the Board determines that such basis does not represent fair value
at the time. Under this method such securities are valued initially at cost on
the date of purchase or, in the case of securities purchased with more than 60
days to maturity, are valued at their market or fair value each day until the
61st day prior to maturity. Thereafter, absent unusual circumstances, a
constant proportionate amortization of any discount or premium is assumed until
maturity of the security.
A pricing service may be used to value certain portfolio
securities where the prices provided are believed to reflect the fair value of
such securities. In valuing securities the pricing service would normally take
into consideration such factors as yield, risk, quality, maturity, type of
issue, trading characteristics, special circumstances and other factors it deems
relevant in determining valuations for normal institutional-sized trading units
of debt securities and would not rely on quoted prices. The methods used by the
pricing service and the valuations so established will be utilized under the
general supervision of the Board. Valuation of options is described above under
"Investment Objective and Policies - Options Trading".
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<PAGE> 245
SUPPLEMENTARY PURCHASE INFORMATION
For the purpose of applying the Right of Accumulation or Letter of
Intent privileges described in the Prospectus, the scale of sales loads applies
to purchases made by any "purchaser," which term includes an individual and/or
spouse purchasing securities for his, her or their own account or for the
account of any minor children; or a trustee or other fiduciary account
(including a pension, profit-sharing or other employee benefit trust created
pursuant to a plan qualified under Section 401 of the Internal Revenue Code)
although more than one beneficiary is involved; or "a qualified group" which
has been in existence for more than six months and has not been organized for
the purpose of buying redeemable securities of a registered investment company
at a discount, provided that the purchases are made through a central
administrator or a single dealer, or by other means which result in economy of
sales effort or expense. A "qualified group" must have more than 10 members,
must be available to arrange for group meetings between representatives of the
Fund and the members, and must be able to arrange for mailings to members at
reduced or no cost to the Distributor. The value of shares eligible for the
Right of Accumulation privilege may also be used as a credit toward completion
of the Letter of Intent privilege. Such shares will be valued at their
offering price prevailing on the date of submission of the Letter of Intent.
Distributions on shares held in escrow pursuant to the Letter of Intent
privilege will be credited to the shareholder, but such shares are not eligible
for the Fund's Exchange Privilege.
The computation of the hypothetical offering price per share for
the Fund based on the value of the Fund's net assets on February 28, 1995 and
the Fund's outstanding securities on such date is as follows:
Corporate Bond Fund
<TABLE>
<S> <C>
Net Assets . . . . . . . . . . . . . . . . . . . . $31,371,909
Outstanding Securities . . . . . . . . . . . . . . 2,087,480
Net Asset Value Per Share . . . . . . . . . . . . . $ 15.03
Sales Charge 4.50 percent
of offering price (4.71
percent of net asset value
per share) . . . . . . . . . . . . . . . . . . . . $ 0.71
Offering to Public . . . . . . . . . . . . . . . . $ 15.74
</TABLE>
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<PAGE> 246
SUPPLEMENTARY REDEMPTION INFORMATION
Shares in the Fund for which orders for wire redemption are
received on a business day before the close of regular trading hours on the New
York Stock Exchange (currently 4:00 p.m. Eastern time) will be redeemed as of
the close of regular trading hours on such Exchange and the proceeds of
redemption (less any applicable contingent deferred sales charge imposed on
shareholders who purchased shares of the Fund of $1 million or more without a
front-end sales load and redeem such shares within 2 years after purchase) will
normally be wired in federal funds on the next business day to the commercial
bank specified by the investor on the Account Application (or other bank of
record on the investor's file with the Transfer Agent). To qualify to use the
wire redemption privilege, the payment for Fund shares must be drawn on, and
redemption proceeds paid to, the same bank and account as designated on the
Account Application (or other bank of record as described above). If the
proceeds of a particular redemption are to be wired to another bank, the request
must be in writing and signature guaranteed. Shares for which orders for wire
redemption are received after the close of regular trading hours on the New York
Stock Exchange or on a non-business day will be redeemed as of the close of
trading on such Exchange on the next day on which shares of the Fund are priced
and the proceeds (less any applicable contingent deferred sales charge imposed
on shareholders who purchased shares of the Fund of $1 million or more without a
front-end sales load and redeem such shares within 2 years after purchase) will
normally be wired in federal funds on the next business day thereafter.
Redemption proceeds (less any applicable contingent deferred sales charge
imposed on shareholders who purchased shares of the Fund of $1 million or more
without a front-end sales load and redeem such shares within 2 years after
purchase) will be wired to a correspondent member bank if the investor's
designated bank is not a member of the Federal Reserve System. Immediate
notification by the correspondent bank to the investor's bank is necessary to
avoid a delay in crediting the funds to the investor's bank account. Proceeds
of less than $1,000 will be mailed to the investor's address.
To change the commercial bank or account designated to receive
redemption proceeds, a written request must be sent to the Company, c/o Pacific
Horizon Funds, Inc., P.O. Box 80221, Los Angeles, California 90080-9909. Such
request must be signed by each shareholder, with each signature guaranteed as
described in the Fund's Prospectus. Guarantees must be signed by an authorized
signatory and "signature guaranteed" must appear with the signature. The
Transfer Agent may request further documentation from corporations, executors,
administrators, trustees or guardians, and will accept other suitable
verification arrangements from foreign investors, such as consular
verification.
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<PAGE> 247
Investors in the Fund redeeming by check generally will be subject
to the same rules and regulations that commercial banks apply to checking
accounts, although the election of this privilege creates only a
shareholder-transfer agent relationship with the Transfer Agent. An investor
may deliver checks directly to the Transfer Agent, BISYS Fund Services Ohio,
Inc., 3435 Stelzer Road, Columbus, Ohio 43219-3035, in which case the proceeds
will be mailed, wired or made available at the Transfer Agent on the next
business day. The check delivered to the Transfer Agent must be accompanied by
a properly executed stock power form on which the investor's signature is
guaranteed as described in the Fund's Prospectus.
Checks may not be used to close an account.
Check redemption may be modified or terminated at any time by the
Company or the Transfer Agent upon notice to shareholders.
SUPPLEMENTARY PURCHASE AND REDEMPTION INFORMATION
In General. As described in the Prospectus, Fund shares may be
purchased directly by the public, by clients of Bank of America through their
qualified trust and agency accounts, or by clients of securities dealers,
financial institutions (including banks) and other industry professionals, such
as investment advisers, accountants and estate planning firms that have entered
into service and/or selling agreements with the Distributor. (The Distributor,
such institutions and professionals are collectively referred to as "Service
Organizations.") Bank of America and Service Organizations may impose minimum
customer account and other requirements in addition to those imposed by the
Fund and described in the Prospectus. Purchase orders will be effected only on
business days.
Shares in the Fund are sold with a sales load, except such
exemptions as noted in the Prospectus. However, there is no front-end sales
load on combined purchases of shares of $1 million or more. Concord Financial
Group, Inc. will pay commissions of up to 1.00% to brokers whose customers
purchase such shares. Additionally, a 1.00% and 0.50% contingent deferred sales
charge is applicable to shareholders who purchase shares of the Fund of $1
million or more without a front-end sales load and redeem such shares within
one year and two years, respectively, after purchase. These exemptions to the
imposition of a sales load are due to the nature of the investors and/or the
reduced sales efforts that will be necessary in obtaining such investments.
Service Organizations may be paid by the Distributor at the Company's expense
for shareholder services. Depending on the terms of the particular account,
Bank of America, its affiliates, and Service Organizations also may charge
their customers fees
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<PAGE> 248
for automatic investment, redemption and other services provided. Such fees
may include, for example, account maintenance fees, compensating balance
requirements or fees based upon account transactions, assets or income. Bank
of America or the particular Service Organization is responsible for providing
information concerning these services and any charges to any customer who must
authorize the purchase of Fund shares prior to such purchase.
Persons wishing to purchase Company shares through their accounts
at Bank of America or a Service Organization should contact such entity directly
for appropriate instructions.
Initial purchases of shares into a new account may not be made by
wire. However, persons wishing to make a subsequent purchase of Company shares
into an already existing account by wire should telephone the Transfer Agent at
(800) 346-2087. The investor's bank must be instructed to wire federal funds to
the Transfer Agent, referring in the wire to the Fund in which such investment
is to be made; the investor's portfolio account number; and the investor's name.
The Transfer Agent may charge a fee to act as Custodian for IRAs,
payment of which could require the liquidation of shares. All fees charged are
described in the appropriate form. Shares may be purchased in connection with
these plans only by direct remittance to the Transfer Agent. Purchases for IRA
accounts will be effective only when payments received by the Transfer Agent are
converted into federal funds. Purchases for these plans may not be made in
advance of receipt of funds.
For processing redemptions, the Transfer Agent may request further
documentation from corporations, executors, administrators, trustees or
guardians. The Transfer Agent will accept other suitable verification
arrangements from foreign investors, such as consular verification.
Investors should be aware that if they have selected the TeleTrade
Privilege, any request for a wire redemption will be effected as a TeleTrade
transaction through the Automated Clearing House (ACH) system unless more
prompt transmittal is specifically requested. Redemption proceeds of a
TeleTrade transaction will be on deposit in the investor's account at the ACH
member bank normally two business days after receipt of the redemption request.
Exchange Privilege. Shareholders in the Pacific Horizon Family of
Funds have an exchange privilege whereby they may exchange all or part of their
Pacific Horizon Shares for shares of other investment portfolios in the Pacific
Horizon Family of Funds. Shareholders may also exchange all or a part of their
Pacific Horizon shares for like shares of an investment
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<PAGE> 249
portfolio of Time Horizon Funds. By use of the exchange privilege, the
investor authorizes the Transfer Agent to act on telephonic, telegraphic or
written exchange instructions from any person representing himself or herself
to be the investor and believed by the Transfer Agent to be genuine. The
Transfer Agent's records of such instructions are binding. The exchange
privilege may be modified or terminated at any time upon notice to
shareholders. For federal income tax purposes, exchange transactions are
treated as sales on which a purchaser will realize a capital gain or loss
depending on whether the value of the shares exchanged is more or less than his
basis in such shares at the time of the transaction.
Exchange transactions described in Paragraphs A, B, C and D below
will be made on the basis of the relative net asset values per share of the
investment portfolios involved in the transaction.
A. Shares of any investment portfolio purchased with a sales load, as
well as additional shares acquired through reinvestment of
dividends or distributions on such shares, may be exchanged
without a sales load for shares of any other investment portfolio
in the Pacific Horizon Family of Funds or the Time Horizon Funds.
B. Shares of any investment portfolio in the Pacific Horizon Family
of Funds or the Time Horizon Funds, acquired by a previous
exchange transaction involving shares on which a sales load has
directly or indirectly been paid (e.g. shares purchased with a
sales load or issued in connection with an exchange transaction
involving shares that had been purchased with a sales load), as
well as additional shares acquired through reinvestment of
dividends or distributions on such shares, may be redeemed and the
proceeds used to purchase without a sales load shares of any other
investment portfolio. To accomplish an exchange transaction under
the provisions of this Paragraph, investors must notify the
Transfer Agent of their prior ownership of shares and their
account number.
C. Shares of any investment portfolio in the Pacific Horizon Family
of Funds may be exchanged without a sales load for shares of any
other investment portfolio in the Family that is offered without a
sales load.
D. Shares of any investment portfolio in the Pacific Horizon Family
of Funds purchased without a sales load may be exchanged without a
sales load for shares in any other portfolio where the investor
involved maintained an account in the Pacific Horizon Family of
Funds before April 20, 1987 or was the beneficial owner of
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<PAGE> 250
shares of Bunker Hill Income Securities, Inc. on the date of its
reorganization into the Fund.
Neither a contingent deferred sales charge nor a front-end sales
load will be imposed at the time of exchange if a shareholder purchases shares
of the Fund of $1 million or more without a front-end sales load and exchanges
such shares for shares of another investment portfolio of the Company or Time
Horizon Funds. However, shares acquired in the exchange are subject to a
contingent deferred sales charge of 1.00% and 0.50%, respectively, on
redemptions within one year and two years after purchase.
Except as stated above, a sales load will be imposed when shares
of any investment portfolio in the Pacific Horizon Family of Funds that were
purchased or otherwise acquired without a sales load are exchanged for shares of
another investment portfolio in the Pacific Horizon Family or the Time Horizon
Funds, which are sold with a sales load.
Exchange requests received on a business day prior to the time
shares of the investment portfolios involved in the request are priced will be
processed on the date of receipt. "Processing" a request means that shares in
the investment portfolio from which the shareholder is withdrawing an
investment will be redeemed at the net asset value per share next determined on
the date of receipt. Shares of the new investment portfolio into which the
shareholder is investing will also normally be purchased at the net asset value
per share next determined coincident to or after the time of redemption.
Exchange requests received on a business day after the time shares of the
investment portfolios involved in the request are priced will be processed on
the next business day in the manner described above.
Miscellaneous. Certificates for shares will not be issued.
Depending on the terms of the customer account at Bank of America
or a Service Organization, certain purchasers may arrange with the Company's
custodian for sub-accounting services paid by the Company without direct charge
to the purchaser.
A "business day" for purposes of processing share purchases and
redemptions received by the Transfer Agent at its Columbus office is a day on
which the New York Stock Exchange is open for trading. In 1996, the holidays
on which the New York Stock Exchange is closed are: New Year's Day,
Presidents' Day, Good Friday, Memorial Day (observed), Independence Day, Labor
Day, Thanksgiving Day and Christmas Day.
The Company may suspend the right of redemption or postpone the
date of payment for shares during any period when (a) trading on the New York
Stock Exchange is restricted by applicable rules and regulations of the SEC;
(b) the New York Stock Exchange is closed for other than customary weekend and
holiday closings; (c) the SEC has by order permitted such suspension; or (d) an
emergency exists as determined by the SEC. (The Company may also suspend or
postpone the recordation of the transfer of its shares upon the occurrence of
any of the foregoing conditions.)
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<PAGE> 251
The Company's Charter permits its Board of Directors to require a
shareholder to redeem involuntarily shares in a Fund if the balance held of
record by the shareholder drops below $500 and such shareholder does not
increase such balance to $500 or more upon 60 days' notice. The Company will
not require a shareholder to redeem shares of the Fund if the balance held of
record by the shareholder is less than $500 solely because of a decline in the
net asset value of the Fund's shares. The Company may also redeem shares
involuntarily if such redemption is appropriate to carry out the Company's
responsibilities under the 1940 Act.
If the Company's Board of Directors determines that conditions
exist which make payment of redemption proceeds wholly in cash unwise or
undesirable, the Company may make payment wholly or partly in securities or
other property. In such an event, a shareholder would incur transaction costs
in selling the securities or other property. The Company has committed that it
will pay all redemption requests by a shareholder of record in cash, limited in
amount with respect to each shareholder during any ninety-day period to the
lesser of $250,000 or 1% of the net asset value at the beginning of such
period.
ADDITIONAL INFORMATION CONCERNING TAXES
FEDERAL
The Fund will be treated as a separate corporate entity under the
Internal Revenue Code of 1986, as amended (the "Code"), and intends to qualify
as a "regulated investment company." By following this policy, the Fund
expects to eliminate or reduce to a nominal amount the federal income taxes to
which it may be subject. If for any taxable year the Fund does not qualify for
the special federal tax treatment afforded regulated investment companies, all
of the Fund's taxable income would be subject to tax at regular corporate rates
(without any deduction for distributions to shareholders). In such event, the
Fund's dividend distributions to shareholders would be taxable as ordinary
income to the extent of the current and accumulated earnings and profits of the
Fund and would be eligible for the dividends received deduction in the case of
corporate shareholders.
Qualification as a regulated investment company under the Code
requires, among other things, that the Fund distribute to its shareholders an
amount equal to at least the sum of 90% of its investment company taxable
income (if any) and 90% of its tax- exempt income (if any), net of certain
deductions for each taxable year. In general, the Fund's investment company
taxable income will be its taxable income, including dividends, interest, and
short-term capital gains (the excess of net short-term
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<PAGE> 252
capital gain over net long-term capital loss), subject to certain adjustments
and excluding the excess of net long-term capital gain, if any, for the taxable
year over the net short-term capital loss (if any), for such year. The Fund
will be taxed on its undistributed investment company taxable income, if any.
As stated, the Fund intends to distribute at least 90% of its investment
company taxable income (if any) for each taxable year. To the extent such
income is distributed by the Fund (whether in cash or additional shares), it
will be taxable to shareholders as ordinary income.
The Fund will not be treated as a regulated investment company
under the Code if 30% or more of the Fund's gross income for a taxable year is
derived from gains realized on the sale or other disposition of the following
investments held for less than three months (the "Short-Short test"): (1)
stock and securities (as defined in section 2(a)(36) of the 1940 Act); (2)
options, futures and forward contracts other than those on foreign currencies;
and (3) foreign currencies (and options, futures and forward contracts on
foreign currencies) that are not directly related to the Fund's principal
business of investing in stock and securities (and options and futures with
respect to stocks and securities). Interest (including original issue discount
and accrued market discount) received by the Fund upon maturity or disposition
of a security held for less than three months will not be treated as gross
income derived from the sale or other disposition of such security within the
meaning of this requirement. However, any other income that is attributable to
realized market appreciation will be treated as gross income from the sale or
other disposition of securities for this purpose. With respect to covered call
options, if the call is exercised by the holder, the premium and the price
received on exercise constitute the proceeds of sale, and the difference
between the proceeds and the cost of the securities subject to the call is
capital gain or loss. Premiums from expired call options written by a Fund and
net gains from closing purchase transactions are treated as short-term capital
gains for federal income tax purposes, and losses on closing purchase
transactions are short-term capital losses. See Appendix B -- "Accounting and
Tax Treatment" -- for a general discussion of the federal tax treatment of
futures contracts, related options thereon and other financial instruments,
including their treatment under the Short-Short test.
Any distribution of the excess of net long-term capital gains over
net short-term capital losses is taxable to shareholders as long-term capital
gains, regardless of how long the shareholder has held Fund shares and whether
such gains are received in cash or additional Fund shares. The Fund will
designate such a distribution as a capital gain dividend in a written notice
mailed to shareholders after the close of the Fund's taxable year. It should
be noted that, upon the sale or
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<PAGE> 253
exchange of Fund shares, if the shareholder has not held such shares for more
than six months, any loss on the sale or exchange of those shares will be
treated as long-term capital loss to the extent of the capital gain dividends
received with respect to the shares.
Ordinary income of individuals is taxable at a maximum nominal
rate of 39.6%, but because of limitations on itemized deductions otherwise
allowable and the phase-out of personal exemptions, the maximum effective
marginal rate of tax for some taxpayers may be higher. An individual's
long-term capital gains are taxable at a maximum nominal rate of 28%. For
corporations, long-term capital gains and ordinary income are both taxable at a
maximum nominal rate of 35% (or at a maximum effective marginal rate of 39%, in
the case of corporations having taxable income between $100,000 and $335,000).
A 4% non-deductible excise tax is imposed on regulated investment
companies that fail to currently distribute specific percentages of their
ordinary taxable income and capital gain net income (excess of capital gains
over capital losses). The Fund intends to make sufficient distributions or
deemed distributions of its ordinary taxable income and any capital gain net
income prior to the end of each calendar year to avoid liability for this
excise tax.
The Company 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 upon sale paid to shareholders (i) who have failed to provide a
correct tax identification number in the manner required, (ii) who are subject
to withholding by the Internal Revenue Service for failure to properly include
on their return payments of taxable interest or dividends or (iii) who have
failed to certify to the Company either that they are subject to backup
withholding when required to do so or that they are "exempt recipients."
At February 28, 1995, the Fund had unused capital loss carryovers
of $8,305,224, some of which may be available to the Fund to offset any future
capital gains on securities transactions to the extent provided in the Code.
STATE
Depending upon the extent of 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, the Fund may be subject to the tax laws of such states or localities.
Income distributions may be taxable to shareholders under state or
local law as dividend income even though all or a
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portion of such distributions may be derived from interest on tax-exempt
obligations or U.S. government obligations which, if realized directly, would
be exempt from such income taxes. Shareholders are advised to consult their
tax advisers concerning the application of state and local taxes.
TAXATION OF THE PORTFOLIO
Management of the Portfolio intends for the Portfolio to be
treated as a partnership (or, in the event that the Fund is the sole investor in
the Portfolio, as an agent or nominee) rather than as a regulated investment
company or a corporation under the Code. Under the rules applicable to a
partnership (or an agent or nominee) under the Code, any interest, dividends,
gains and losses of the Portfolio will be deemed to have been "passed through"
to its investors regardless of whether any amounts are actually distributed by
the Portfolio.
Each investor in the Portfolio will be taxed on its share (as
determined in accordance with the governing instruments of the Portfolio) of
the Portfolio's ordinary income and capital gains in determining its income tax
liability. The determination of such share will be made in accordance with the
Code and regulations promulgated thereunder. It is intended that the
Portfolio's assets, income and distributions will be managed in such a way that
an investor in the Portfolio will be able to satisfy the requirements of
Sub-chapter M of the Code, assuming that the investor invested all of its
assets in the Portfolio.
GENERAL
The foregoing discussion is based on tax laws and regulations
which are in effect on the date of this Statement of Additional Information.
Such laws and regulations may be changed by legislative or administrative
action. This discussion is only a summary of some of the important tax
considerations generally affecting purchasers of Fund shares. No attempt is
made to present a detailed explanation of the federal income tax treatment of
the Fund or its shareholders, and this discussion is not intended as a
substitute for careful tax planning. Accordingly, potential purchasers of Fund
shares should consult their tax advisers with specific reference to their own
tax situation.
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MANAGEMENT
DIRECTORS AND OFFICERS OF THE COMPANY
The directors and officers of the Company, their addresses, ages
and principal occupations during the past five years are:
<TABLE>
<CAPTION>
Position with
Name and Address Age Company Principal Occupations
- ---------------- --- ------- ---------------------
<S> <C> <C> <C>
Thomas M. Collins 61 Director Of counsel, law firm of
McDermott & Trayner McDermott & Trayner;
225 S. Lake Avenue Partner of the law firm
Suite 410 of Musick, Peeler &
Pasadena, CA 91101-3005 Garrett (until April,
1993); Trustee, Master
Investment Trust Series
I and Master Investment
Trust, Series II
(registered investment
companies) (since 1993);
former Director, Bunker
Hill Income Securities,
Inc. (registered
investment company)
through 1991.
Douglas B. Fletcher 70 Vice Chairman Chairman of the Board
Fletcher Capital of the Board and Chief Executive
Advisors Incorporated Officer, Fletcher
4 Upper Newport Plaza Capital Advisors,
Suite 100 Incorporated, (registered
Newport Beach, CA 92660-2629 investment adviser) 1991
to date;
Partner, 1991 Newport
Partners (private
venture capital firm),
1981 to date; Chairman
of the Board and Chief
Executive Officer, First
Pacific Advisors, Inc.
(registered investment
adviser) and seven
investment companies
under its management,
prior to 1983; former
Allied Member, New York
Stock Exchange; Chairman
of the Board of FPA
Paramount Fund, Inc.
through 1984; Director,
TIS Mortgage Investment
Company (real estate
investment trust);
Trustee and former Vice
Chairman of the Board,
</TABLE>
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<PAGE> 256
<TABLE>
<CAPTION>
Position with
Name and Address Age Company Principal Occupations
- ---------------- --- ------- ---------------------
<S> <C> <C> <C>
Claremont McKenna
College; Chartered
Financial Analyst.
Robert E. Greeley 62 Director Chairman, Page Mill
Page Mill Asset Asset Management (a
Management private investment
433 California Street company) since 1991;
Suite 900 Manager, Corporate
San Francisco, CA 94104 Investments, Hewlett
Packard Company from
1979 to 1991; Trustee,
Master Investment Trust,
Series I and Master
Investment Trust, Series
II (since 1993);
Director, Morgan
Grenfell Small Cap Fund
(since 1986); former
Director, Bunker Hill
Income Securities, Inc.
(since 1989) (registered
investment companies);
former Trustee,
SunAmerica Fund Group
(previously Equitec
Siebel Fund Group) from
1984 to 1992.
Kermit O. Hanson 79 Director Vice Chairman of the
17760 14th Ave., N.W. Advisory Board, 1988 to
Seattle, WA 98177 date, Executive
Director, 1977 to 1988,
Pacific Rim Bankers
Program (a non-profit
educational
institution); Dean
Emeritus, 1981 to date,
Dean, 1964-81, Graduate
School of Business
Administration,
University of
Washington; Director,
Washington Federal
Savings & Loan
Association; Trustee,
Seafirst Retirement
Funds (since 1993)
(registered investment
company).
</TABLE>
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<PAGE> 257
<TABLE>
<CAPTION>
Position with
Name and Address Age Company Principal Occupations
- ---------------- --- ------- ---------------------
<S> <C> <C> <C>
Cornelius J. Pings* 66 Chairman of President, Association
Association of American the Board and of American
Universities President Universities, February
One DuPont Circle 1993 to date; Provost,
Suite 730 1982 to January
Washington, DC 20036 1993, Senior Vice
President for Academic
Affairs, 1981 to January
1993, University of
Southern California;
Trustee, Master
Investment Trust, Series
I and Master Investment
Trust, Series II (since
1995).
Kenneth L. Trefftzs 83 Director Private Investor;
11131 Briarcliff Drive formerly Distinguished
San Diego, CA 92131-1329 Emeritus Professor
of Finance and Chairman
of the Department of
Finance and Business
Economics of the
Graduate School of
Business of the
University of Southern
California; former
Director, Metro Goldwyn
Mayer, Inc.; Director,
Fremont General
Corporation (insurance
and financial services
holding company);
Director, Source
Capital, Inc.
(closed-end investment
company); Director of
three open-end
investment companies
managed by First Pacific
Advisors, Inc.; formerly
Chairman of the Board of
Directors (or Trustees)
of nineteen investment
companies managed by
American Capital Asset
Management, Inc.
</TABLE>
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<PAGE> 258
<TABLE>
<CAPTION>
Position with
Name and Address Age Company Principal Occupations
- ---------------- --- ------- ---------------------
<S> <C> <C> <C>
Richard E. Stierwalt Executive Chairman of the Board
125 W. 55th Street 40 Vice President and Chief Executive
New York, NY 10019 Officer, July 1993 to
date, prior thereto
Senior Director,
Managing Director and
Chief Executive Officer
of the Administrator and
Distributor, February
1987 to July 1993;
President, Master
Investment Trust, Series
I, Master Investment
Trust, Series II and
Seafirst Retirement
Funds (since 1993);
First Vice President,
Trust Operation
Administration, Security
Pacific National Bank,
1983-1987.
William B. Blundin 57 Executive Vice Vice Chairman, July 1993
125 W. 55th Street President to date, prior thereto
New York, NY 10019 Director and President
of the Administrator and
Distributor, February
1987 to July 1993;
Executive Vice
President, Master
Investment Trust, Series
II and Seafirst
Retirement Funds (since
1993); Senior Vice
President, Shearson
Lehman Brothers,
1978-1987.
Irimga McKay 35 Vice Senior Vice President,
7863 Girard Avenue President July 1993 to date, prior
Suite 306 thereto First Vice
La Jolla, CA 92037 President of the
Administrator and
Distributor, November
1988 to July 1993; Vice
President, Master
Investment Trust, Series
II and Seafirst
Retirement Funds (since
1993); Regional Vice
President, Continental
Equities, June 1987 to
November 1988; Assistant
</TABLE>
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<PAGE> 259
<TABLE>
<CAPTION>
Position with
Name and Address Age Company Principal Occupations
- ---------------- --- ------- ---------------------
<S> <C> <C> <C>
Wholesaler, VMS Realty
Partners (a real estate
limited partnership),
May 1986 to June 1987.
W. Eugene Spurbeck 39 Assistant Vice Manager of Client
BISYS Fund Services President Services of the
515 Figueroa Street Administrator (1993 to
Suite 335 date); Assistant Vice
Los Angeles, CA 92307 President, Master
Investment Trust, Series
II; Vice President,
Seafirst Retirement
Funds (since 1995); Vice
President of Retail
Lending Operations Banc
One (1989 to 1993).
Martin R. Dean 31 Treasurer Manager of Fund
3435 Stelzer Road Accounting of BISYS
Columbus, OH 43219 Fund Services, May 1994
to Present; Treasurer,
Master Investment Trust,
Series II and Seafirst
Retirement Funds (since
1995); Senior Manager at
KPMG Peat Marwick
previously 1990-1994.
W. Bruce McConnel, III 52 Secretary Partner of the law firm
1345 Chestnut Street of Drinker Biddle &
Philadelphia National Bank Reath. Secretary,
Building, Suite 1100 Master Investment Trust,
Philadelphia, PA 19107 Series I, Master
Investment Trust, Series
II and Seafirst
Retirement Funds
George O. Martinez 35 Assistant Senior Vice President
3435 Stelzer Road Secretary and Director of Legal
Columbus, OH 43219 and Compliance Services,
of the Administrator.
since April 1995;
Assistant Secretary,
Master Investment Trust,
Series II and Seafirst
Retirement Funds (since
1995); prior thereto,
Vice President and
Associate General
Counsel, Alliance
Capital Management, L.P.
</TABLE>
- --------------------
* Mr. Pings is an "interested director" of the Company as defined in the
1940 Act.
-37-
<PAGE> 260
The Audit Committee of the Board is comprised of all directors and
is chaired by Dr. Trefftzs. The Board does not have an Executive Committee.
Each director is entitled to receive an annual fee of $25,000 plus
$1,000 for each day that a director participates in all or part of a Board
Meeting; the President receives an additional $20,000 per annum for his services
as President; Mr. Collins, in consideration of his years of service as President
and Chairman of the Board, receives an additional $40,000 per annum in severance
until February 28, 1997; each member of a Committee of the Board is entitled to
receive $1,000 for each Committee meeting they participate in (whether or not
held on the same day as a Board meeting); and each Chairman of a Committee of
the Board shall be entitled to receive an annual retainer of $1,000 for his
services as Chairman of the Committee. The Fund and each other fund of the
Company pays its proportionate share of these amounts based on relative net
asset values.
For the fiscal year ended February 28, 1995, the Company paid or
accrued for the account of its directors as a group for services in all
capacities a total of $334,168; of this amount $4,099 was allocated to the Fund.
Each director is also reimbursed for out-of-pocket expenses incurred as a
director. Drinker Biddle & Reath, of which Mr. McConnel is a partner, receives
legal fees as counsel to the Company. As of the date of this Statement of
Additional Information, the directors and officers of the Company, as a group,
owned less than 1% of the outstanding shares of each of the Company's investment
portfolios.
Under a retirement plan approved by the Board, including a
majority of its directors who are not "interested persons" of the Company,
effective March 1, 1995, a director who dies or resigns after five years of
service is entitled to receive ten annual payments each equal to the greater of:
(i) 50% of the annual director's retainer that was payable by the Company during
the year of his/her death or resignation, or (ii) 50% of the annual director's
retainer then in effect for directors of the Company during the year of such
payment. A director who dies or resigns after nine years of service is entitled
to receive ten annual payments each equal to the greater of: (i) 100% of the
annual director's retainer that was payable by the Company during the year of
his/her death or resignation, or (ii) 100% of the annual director's retainer
then in effect for directors of the Company during the year of such payment.
Further, the amount payable each year to a director who dies or resigns is
increased by $1,000 for each year of service that the director provided as
Chairman of the Board.
Years of service for purposes of calculating the benefit described
above are based upon service as a director or
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<PAGE> 261
Chairman after February 28, 1994. Retirement benefits in which a director has
become vested may not be reduced by later Board action.
In lieu of receiving ten annual payments, a director may elect to
receive substantially equivalent benefits through a single-sum cash payment of
the present value of such benefits paid by the Company within 45 days of the
death or resignation of the director. The present value of such benefits is to
be calculated (i) based on the retainer that was payable by the Company during
the year of the director's death or resignation (and not on any retainer payable
to directors thereafter), and (ii) using the interest rate in effect as of the
date of the director's death or resignation by the Pension Benefit Guaranty
Corporation (or any successor thereto) for valuing immediate annuities under
terminating defined benefit pension plans. A director's election to receive a
single sum must be made in writing within the 30 calendar days after the date
the individual is first elected as a director.
In addition to the foregoing, the Board of Directors may, in its
discretion and in recognition of a director's period of service before March 1,
1994 as a director and possibly as Chairman, authorize the Company to pay a
retirement benefit following the director's death or resignation (unless the
director has vested benefits as a result of completing nine years of service).
Any such action shall be approved by the Board and by a majority of the
directors who are not "interested persons" of the Company within 120 days
following the director's death or resignation and may be authorized as a single
sum cash payment or as not more than ten annual payments (beginning the first
anniversary of the director's date of death or resignation and continuing for
one or more anniversary date(s) thereafter).
The obligation of the Company to pay benefits to a former director
is neither secured nor funded by this Company but shall be binding upon its
successors in interest. The payment of such benefits under the retirement plan
has no priority or preference over the lawful claims of the Company's creditors
or shareholders, and the right to receive such payments is not assignable or
transferable by a director (or former director) other than by will, by the laws
of descent and distribution, or by the director's written designation of a
beneficiary.
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<PAGE> 262
TRUSTEES AND OFFICERS OF MASTER INVESTMENT TRUST, SERIES I
The trustees and officers of Master Investment Trust, Series I
(the "Master Trust"), a Delaware business trust of which the Portfolio is a
series, their addresses, ages and principal occupation during the past five
years are:
<TABLE>
<CAPTION>
Position with
Name and Address Age the Master Trust Principal Occupations
- ---------------- --- ---------------- ---------------------
<S> <C> <C> <C>
Thomas M. Collins 61 Chairman of See "Directors and
McDermott & Trayner the Board Officers of the
225 S. Lake Avenue, Company."
Suite 410
Pasadena, CA 91101-3005
Michael Austin 59 Trustee Chartered Accountant;
Victory House, Trustee, Master
Nelson Quay Investment Trust,
Governor's Harbour Series II (since 1993)
Grand Cayman Retired Partner, KPMG
Cayman Islands Peat Marwick LLP.
British West Indies
Robert E. Greeley 62 Trustee See "Directors and
Page Mill Asset Officers of the Company".
Management
433 California Street
Suite 900
San Francisco, CA 94104
Robert A. Nathane* 70 Trustee Retired President, Laird
1200 Shenandoah Drive East Norton Trust Company,
Seattle, WA 98112 Chairman of the Board of
Advisors, Phoenix Venture
Funds; Trustee, Seafirst
Retirement Funds; Trustee,
Master Investment Trust,
Series II (since 1993);
former Supervisor,
Collective Investment Trust
for Seafirst Retirement
Accounts; former Trustee,
First Funds of America
(registered investment
companies).
</TABLE>
<TABLE>
<CAPTION>
Position with
Name and Address Age the Master Trust Principal Occupations
- ---------------- --- ---------------- ---------------------
<S> <C> <C> <C>
Cornelius J. Pings 66 Trustee See "Directors and Officers of
Association of American the Company".
</TABLE>
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<PAGE> 263
<TABLE>
<S> <C> <C> <C>
Universities
One DuPont Circle
Suite 730
Washington, DC 20036
Richard E. Stierwalt 40 President See "Directors and
125 West 55th Street Officers of the Company."
New York, NY 10019
Adrian J. Waters 32 Executive Vice Managing Director,
ITI House President, Concord Management
23 Earlsfort Terrace Treasurer and (Ireland) Ltd. since May
Dublin 2, Ireland Assistant 1993; Manager in the
Investment Secretary Company Industry Services
Group, Price Waterhouse
1989 to May 1993; Member of
Oliver Freaney and
Co./Spicer and Openheim
Chartered Accountants
1986-1989.
W. Bruce McConnel, III 52 Secretary See "Directors and
1345 Chestnut Street Officers of the Company."
Philadelphia, PA 19107
</TABLE>
____________________
* Mr. Nathane is an "interested trustee" of the Master Trust as defined
in the 1940 Act.
Each trustee receives an aggregate annual fee of $1500 plus $500 per
meeting attended and $250 for each full day spent in traveling to or from
meetings, for his services as trustee of the Master Trust. For the fiscal year
ended February 28, 1995, the Master Trust paid or accrued for the account of
its trustees as a group for services in all capacities a total of $30,221, of
this amount $1,661 was allocated to the Portfolio. Each trustee is also
reimbursed for out-of-pocket expenses incurred as a trustee. The trustees'
fees and reimbursements are allocated among all of the Master Trust's
portfolios based on relative net asset values.
-41-
<PAGE> 264
The following chart provides certain information about the
director/trustee fees of the Company's and Master Trust's directors/trustees as
of February 28, 1995:
<TABLE>
<CAPTION>
PENSION OR
RETIREMENT TOTAL
AGGREGATE BENEFITS COMPENSATION FROM
AGGREGATE COMPENSATION ACCRUED AS PART ESTIMATED REGISTRANT AND
NAME OF PERSON/ COMPENSATION FROM FROM THE OF FUND ANNUAL BENEFITS FUND COMPLEX*
POSITION THE COMPANY MASTER TRUST EXPENSES UPON RETIREMENT PAID TO DIRECTORS
--------------- ----------------- ------------ --------------- --------------- -----------------
<S> <C> <C> <C> <C> <C>
Thomas M. Collins $100,000 $5,000 $0 $0 $110,000
President and
Chairman of the
Board+
Douglas B. Fletcher $57,500 $0 $0 $0 $57,500
Vice Chairman of the
Board
Robert E. Greeley** $57,500 $4,750 $0 $0 $65,781
Director
Kermit O. Hanson $57,500 $0 $0 $0 $63,500
Director
Cornelius J. Pings $57,500 $0 $0 $0 $57,500
Director
Kenneth L. Trefftzs $57,500 $0 $0 $0 $57,500
Director
- --------------------
</TABLE>
* The "Fund Complex" consists of the Company, Seafirst Retirement Funds,
the Master Trust and Master Investment Trust, Series II.
** Mr. Greeley became a director of the Company on April 25, 1994.
+ Mr. Collins was President and Chairman of the Board of the Company
until August 31, 1995.
INVESTMENT ADVISER
Bank of America is the successor by merger to Security Pacific
National Bank ("Security Pacific"), which previously served as investment
adviser to the other investment portfolios of the Company since the
commencement of its operations. As described in the Prospectus, the Fund has
not retained the services of an investment adviser since it seeks to achieve
its investment objective by investing all of its assets in the
-42-
<PAGE> 265
Portfolio. In the Investment Advisory Agreement with the Master Trust, Bank of
America has agreed to provide investment advisory services to the Portfolio as
described in the Prospectus. Bank of America has also agreed to pay all
expenses incurred by it in connection with its activities under its agreement
other than the cost of securities, including brokerage commissions, if any,
purchased for the Portfolio. In rendering its advisory services, Bank of
America may utilize Bank officers from one or more of the departments of the
Bank which are authorized to exercise the fiduciary powers of Bank of America
with respect to the investment of trust assets. In some cases, these officers
may also serve as officers, and utilize the facilities, of wholly-owned
subsidiaries and other affiliates of Bank of America or its parent corporation.
For the services provided and expenses assumed pursuant to the Investment
Advisory Agreement for the Portfolio, the Master Trust has agreed to pay Bank
of America fees, accrued daily and payable monthly, at the annual rate of .45%
of the average daily net assets of the Portfolio. The fees payable to Bank of
America are not subject to reduction as the value of the Portfolio's net assets
increases. From time to time, Bank of America may waive fees or reimburse the
Company or the Portfolio for expenses voluntarily or as required by certain
state securities laws.
For the fiscal period October 1, 1994 through February 28, 1995,
Bank of America waived all advisory fees payable to it by the Portfolio,
amounting to $58,897. For the period April 25, 1994 (the date the Predecessor
Fund was reorganized into the Fund) through September 30, 1994, Bank of America
waived all advisory fees payable to it by the Portfolio, amounting to $73,575.
See "Management -- Administrator" for instances where the investment advisor is
required to make expense reimbursements to the Portfolio.
Prior to its reorganization into the Fund, the Predecessor Fund
was advised by Security Pacific Investment Management, Inc. ("SPIM"), an
affiliate of Bank of America, until December 8, 1993 when SPIM transferred its
rights and obligations under its advisory agreement with the Predecessor Fund
(the "Prior Agreement") to Bank of America, which thereafter served as
investment adviser. For the period October 1, 1993 through April 24, 1994 and
the fiscal years ended September 30, 1993 and 1992, the Predecessor Fund paid
$129,586, $228,245 and $218,010, respectively, in investment advisory fees to
SPIM (and Bank of America after December 8, 1993), pursuant to the Prior
Agreement.
The Investment Advisory Agreement between the Master Trust and Bank
of America (the "Investment Advisory Agreement") is dated October 25, 1993, as
amended through April 26, 1994. The Investment Advisory Agreement will be in
effect until October 31, 1995, and will continue in effect from year to year
thereafter only so long as such continuation is approved at least
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<PAGE> 266
annually by (i) the Board of Trustees of the Master Trust or the vote of a
"majority," as defined in the 1940 Act, of the outstanding voting securities of
the Master Trust, and (ii) a majority of those trustees of the Master Trust who
are not "interested persons," as defined in the 1940 Act, of any party to the
Investment Advisory Agreement, acting in person at a meeting called for the
purpose of voting on such approval. The Investment Advisory Agreement will
terminate automatically in the event of its "assignment," as defined in the
1940 Act. In addition, the Investment Advisory Agreement is terminable at any
time without penalty upon 60 days' written notice by the Board of Trustees of
the Master Trust, by vote of the holders of a majority of the Portfolio's
outstanding voting securities, or by Bank of America.
The Investment Advisory Agreement for the Portfolio provides that
Bank of America shall not be liable for any error of judgment or mistake of law
or for any loss suffered in connection with the performance of the Investment
Advisory Agreement, except a loss resulting from a breach of fiduciary duty
with respect to the receipt of compensation for services or a loss resulting
from willful misfeasance, bad faith or negligence in the performance of its
duties or from reckless disregard by it of its duties and obligations
thereunder.
THE GLASS-STEAGALL ACT AND PROPOSED LEGISLATION
The Glass-Steagall Act, among other things, prohibits banks from
engaging in the business of underwriting securities, although national and
state-chartered banks generally are permitted to purchase and sell securities
upon the order and for the account of their customers. In 1971, the United
States Supreme Court held in Investment Company Institute v. Camp that the
Glass- Steagall Act prohibits a national bank from operating a fund for the
collective investment of managing agency accounts. Subsequently, the Board of
Governors of the Federal Reserve System (the "Board") issued a regulation and
interpretation to the effect that the Glass-Steagall Act and such decision
forbid a bank holding company registered under the Federal Bank Holding Company
Act of 1956 (the "Holding Company Act") or any non-bank affiliate thereof from
sponsoring, organizing or controlling a registered, open-end investment company
continuously engaged in the issuance of its shares, but do not prohibit such a
holding company or affiliate from acting as investment adviser, transfer agent
and custodian to such an investment company. In 1981, the United States
Supreme Court held in Board of Governors of the Federal Reserve System v.
Investment Company Institute that the Board did not exceed its authority under
the Holding Company Act when it adopted its regulation and interpretation
authorizing bank holding companies and their non-bank affiliates to act as
investment advisers to registered closed-end investment companies.
-44-
<PAGE> 267
Bank of America believes that if the question were properly
presented, a court should hold that Bank of America may perform the services
for the Portfolio contemplated by the Investment Advisory Agreement as
described in the Prospectus, and this Statement of Additional Information
without violation of the Glass-Steagall Act or other applicable banking laws or
regulations. It should be noted, however, that there have been no cases
deciding whether a national bank may perform services comparable to those
performed by Bank of America and that future changes in either federal or state
statutes and regulations relating to permissible activities of banks or trust
companies and their subsidiaries or affiliates, as well as further judicial or
administrative decisions or interpretations of present and future statutes and
regulations, could prevent Bank of America from continuing to perform such
services for the Portfolio or from continuing to purchase Fund shares for the
accounts of its customers. (For a discussion of the Glass Steagall Act in
connection with the Company's Shareholder Service Plan, see "Plan Payments" in
the Fund's Prospectus.)
On the other hand, as described herein, the Fund is currently
distributed by Concord Financial Group, Inc. Concord Holding Corporation, its
parent, either directly or through its off-shore subsidiary, provides the
Portfolio and the Fund with administrative services. If current restrictions
under the Glass-Steagall Act preventing a bank from sponsoring, organizing,
controlling, or distributing shares of an investment company were relaxed, the
Company and the Master Trust expect that Bank of America would consider the
possibility of offering to perform some or all of the services now provided by
Concord Holding Corporation or Concord Financial Group, Inc. From time to
time, legislation modifying such restriction has been introduced in Congress
which, if enacted, would permit a bank holding company to establish a non-bank
subsidiary having the authority to organize, sponsor and distribute shares of
an investment company. If this or similar legislation were enacted, the
Company and the Master Trust expect that Bank of America's parent bank holding
company would consider the possibility of one of its non-bank subsidiaries
offering to perform some or all of the services now provided by Concord Holding
Corporation or Concord Financial Group, Inc. It is not possible, of course, to
predict whether or in what form such legislation might be enacted or the terms
upon which Bank of America or such a non-bank affiliate might offer to provide
services for consideration by the Company's Board of Directors or the Master
Trust's Board of Trustees.
ADMINISTRATOR
Concord Holding Corporation (the "Administrator"), with offices at
125 W. 55th Street, New York, New York 10019 and 3435 Stelzer Road, Columbus,
Ohio 43219, is a wholly-owned subsidiary
-45-
<PAGE> 268
of The BISYS Group, Inc. The Administrator also serves as administrator to
several other investment companies.
The Administrator (and/or its off-shore affiliate), provides
administrative services to the Company and the Portfolio as described in the
Fund's Prospectus pursuant to separate administration agreements for the
Company and the Master Trust. The Portfolio's administration agreement will
continue in effect until October 31, 1996 and thereafter for successive periods
of one year, provided the agreement is not sooner terminated. The Portfolio's
administration agreement is terminable at any time with respect to the
Portfolio by the Portfolio's Board of Directors or by a vote of a majority of
the Portfolio's outstanding interests upon 60 days' notice to the
Administrator, or by the Administrator upon 90 days' notice to the Portfolio.
The Fund's administration agreement will continue in effect until October 31,
1996 and thereafter will be extended for successive periods of one year,
provided that each such extension is specifically approved (a) by vote of a
majority of those members of the Company's Board of Directors who are not
interested persons of any party to the agreement, cast in person at a meeting
called for the purpose of voting on such approval, and (b) the Company's Board
of Directors or by vote of a majority of the outstanding voting securities of
the Fund. The agreement is terminable at any time without penalty by the
Company's Board of Directors or by a vote of a majority of the Fund's
outstanding shares upon 60 days' notice to the Administrator, or by the
Administrator upon 90 days' notice to the Company.
The Company has agreed to pay the Administrator a fee for its
services as Administrator, accrued daily and payable monthly, at the annual
rate of .15% of the average daily net assets of the Fund. Similarly, the
Portfolio has agreed to pay the Administrator a fee for its services, accrued
daily and payable monthly, at the annual rate of .05% of the average daily net
assets of the Portfolio. The fees payable to the Administrator are not subject
to reduction as the value of the Fund's and the Portfolio's net assets
increases. From time to time, the Administrator may waive fees or reimburse
the Portfolio or the Fund for expenses, either voluntarily or as required by
certain state securities laws.
For the fiscal period October 1, 1994 through February 28, 1995,
the Administrator waived all administration fees payable to it by the Portfolio
and the Fund, amounting to $6,544 and $19,569, respectively. For the period
April 25, 1994 (the date the Predecessor Fund was reorganized into the Fund)
through September 30, 1994, the Administrator waived all administration fees
payable to it by the Portfolio and the Fund, amounting to $8,175 and $24,407,
respectively.
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<PAGE> 269
For the period October 1, 1993 through April 25, 1994, and the
fiscal years ended September 30, 1993 and 1992, SPIM, the former adviser to the
Predecessor Fund, and not the Predecessor Fund, paid Concord $26,157, $45,649
and $43,602, respectively, for certain administrative services provided to the
Predecessor Fund pursuant to a Sub-Administrative Agreement between SPIM and
Concord.
If total expenses borne directly or indirectly by the Fund in any
fiscal year exceed the expense limitations imposed by applicable state
securities regulations, the Company and the Portfolio may deduct from the
payments to be made by the Fund and the Portfolio to Bank of America and the
Administrator, respectively, or Bank of America and the Administrator each will
bear, the amount of such excess to the extent required by such regulations in
proportion to the fees otherwise payable to them for such year. Such amount,
if any, will be estimated, reconciled and effected or paid, as the case may be,
on a monthly basis. As of the date of this Statement of Additional
Information, the most restrictive expense limitation that may be applicable to
the Company or the Fund limits aggregate annual expenses with respect to the
Fund (including management and advisory fees and the Fund's pro-rata share of
such expenses of the Portfolio but excluding interest, taxes, brokerage
commissions, and certain other expenses) to 2-1/2% of the first $30 million of
its average daily net assets, 2% of the next $70 million, and 1-1/2% of its
remaining average daily net assets. During the course of the Company's fiscal
year, the Administrator and Bank of America may assume certain expenses and/or
not receive payment of fees of the Fund or Portfolio, while retaining the
ability to be reimbursed by the Fund or Portfolio for such amounts prior to the
end of the fiscal year. This will have the effect of increasing yield to
investors at the time such fees are not received or amounts are assumed and
decreasing yield when such fees or amounts are reimbursed.
The Administrator will bear all expenses in connection with the
performance of its services under the administration agreements with the
exception of the fees charged by PFPC, Inc. ("PFPC") for certain fund
accounting services which are borne by the Fund and the Portfolio. Expenses
borne by the Fund and/or Portfolio include taxes, interest, brokerage fees and
commissions, if any, fees of Board members who are not officers, directors,
partners, employees or holders of 5% or more of the outstanding voting
securities of Bank of America or the Administrator or any of their affiliates,
SEC fees and state securities qualification fees, advisory fees, administration
fees, charges of custodians, transfer and dividend disbursing agents' fees,
certain insurance premiums, outside auditing and legal expenses, costs of
maintaining corporate existence, costs attributable to investor services,
including without limitation telephone and personnel expenses, costs of
preparing and printing
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<PAGE> 270
prospectuses and Statements of Additional Information for regulatory purposes,
cost of shareholders' or interestholders reports and corporate meetings and any
extraordinary expenses. Certain shareholder servicing fees in connection with
the Company's shares are also paid by the Company. See "Distributor and Plan
Payments."
The administration agreements provide that the Administrator shall
not be liable for any error of judgment or mistake of law or any loss suffered
by the Company or the Portfolio in connection with the performance of the
administration agreements, except a loss resulting from willful misfeasance,
bad faith or negligence in the performance of its duties or from the reckless
disregard by it of its obligations and duties thereunder.
PFPC provides the Fund and Portfolio with certain accounting
services pursuant to separate fund accounting services agreements with the
Administrator. Under the fund accounting services agreements, PFPC has agreed
to provide certain accounting, bookkeeping, pricing, dividend and distribution
calculation services with respect to the Company and the Portfolio,
respectively. The monthly fees charged by PFPC under the fund accounting
services agreements are borne by the Fund and the Portfolio, respectively.
DISTRIBUTOR AND PLAN PAYMENTS
Concord Financial Group, Inc. (the "Distributor"), a wholly-owned
subsidiary of the Administrator, acts as distributor of the shares of the
Company. Shares are sold on a continuous basis by the Distributor. The
Distributor has agreed to use its best efforts to solicit orders for the sale
of the Company's shares although it is not obliged to sell any particular
amount of shares. The distribution agreement shall continue in effect until
October 31, 1996. Thereafter, if not terminated, the distribution agreement
shall continue automatically for successive terms of one year, provided that
such continuance is specifically approved at least annually (a) by a vote of a
majority of those members of the Board of Directors of the Company who are not
parties to the distribution agreement or "interested persons" of any such
party, cast in person at a meeting called for the purpose of voting on such
approval, and (b) by the Board of Directors of the Company or by vote of a
"majority of the outstanding voting securities" of the Fund as to which the
distribution agreement is effective; provided, however, that the distribution
agreement may be terminated by the Company at any time, without the payment of
any penalty, by vote of a majority of the entire Board of Directors of the
Company or by a vote of a "majority of the outstanding voting securities" of
the Fund on 60 days' written notice to the Distributor, or by the Distributor
at any time, without the payment of any penalty, on
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90 days' written notice to the Company. The agreement will automatically and
immediately terminate in the event of its "assignment."
For the period of October 1, 1994 through February 28, 1995, the
Distributor received $11,175 in sales loads in connection with share purchases,
of which the Distributor and various affiliates of Bank of America retained
$1,436 and $9,326, respectively. The balance was paid to selling dealers. For
the period April 25, 1994 (the date the Predecessor Fund reorganized into the
Fund) through September 30, 1994, the Distributor received $1,485 in sales
loads in connection with share purchases, of which the Distributor and various
affiliates of Bank of America retained $125 and $1,175, respectively. The
balance was paid to selling dealers. As the Predecessor Fund was a closed-end
fund, no commissions were earned during the period October 1, 1993 through
April 24, 1994.
The Distributor is entitled to payment by the Company for certain
shareholder servicing expenses, in addition to the sales load described above
and in the Prospectus, under the Shareholder Service Plan (the "Plan") adopted
by the Company. Under the Plan, the Company pays the Distributor, with respect
to the Fund for (a) non-distribution shareholder services provided by the
Distributor to Service Organizations and/or the beneficial owners of Fund
shares, including, but not limited to shareholder servicing provided by the
Distributor at facilities dedicated for Company use, provided such shareholder
servicing is not duplicative of the servicing otherwise provided on behalf of
the Fund, and (b) fees paid to Service Organizations (which may include the
Distributor itself) for the provision of support services for shareholders for
whom the Service Organization is the dealer of record or holder of record or
with whom the Service Organization has a servicing relationship ("Clients").
Support services provided by Service Organizations may include,
among other things: (i) establishing and maintaining accounts and records
relating to Clients that invest in Fund shares; (ii) processing dividend and
distribution payments from the Fund on behalf of Clients; (iii) providing
information periodically to Clients regarding their positions in shares; (iv)
arranging for bank wires; (v) responding to Client inquiries concerning their
investments in Fund shares; (vi) providing the information to the Fund
necessary for accounting or subaccounting; (vii) if required by law, forwarding
shareholder communications from the Fund (such as proxies, shareholder reports,
annual and semi-annual financial statements and dividend, distribution and tax
notices) to Clients; (viii) assisting in processing exchange and redemption
requests from Clients; (ix) assisting Clients in changing dividend options,
account designations and addresses; and (x) providing such other similar
services.
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The Shareholder Service Plan provides that the Distributor is
entitled to receive payments for expenses on a monthly basis, at an annual rate
not exceeding 0.25% of the average daily net assets of the Fund during such
month for shareholder servicing expenses. The calculation of a Fund's average
daily net assets for these purposes does not include assets held in accounts
opened via a transfer of assets from trust and agency accounts of Bank of
America. Further, payments made out of or charged against the assets of the
Fund must be in payment for expenses incurred on behalf of the Fund.
If in any month the Distributor expends or is due more monies than
can be immediately paid due to the percentage limitation described above, the
unpaid amount is carried forward from month to month while the Plan is in
effect until such time, if ever, when it can be paid in accordance with such
percentage limitations. Conversely, if in any month the Distributor does not
expend the entire amount then available under the Plan, and assuming that no
unpaid amounts have been carried forward and remain unpaid, then the amount not
expended will be a credit to be drawn upon by the Distributor to permit future
payment. However, any unpaid amounts or credits due under the Plan may not be
"carried forward" beyond the end of the fiscal year in which such amounts or
credits due are accrued.
For the period of October 1, 1994 through February 28, 1995, the
Distributor waived all Shareholder Service fees payable under the Plan in the
amount of $32,614. For the period April 25, 1994 (the date the Predecessor
Fund reorganized into the Fund) through September 30, 1994, the Distributor
waived all Shareholder Service fees payable under the Plan in the amount of
$40,679.
Payments for shareholder service expenses under the Shareholder
Service Plan are not subject to Rule 12b-1 (the "Rule") under the 1940 Act.
Pursuant to the Shareholder Service Plan, the Distributor provides that a
report of the amounts expended under the Plan, and the purposes for which such
expenditures were incurred, will be made to the Board of Directors for its
review at least quarterly. In addition, the Plan provides that the selection
and nomination of the directors of the Company who are not "interested persons"
of the Company have been committed to the discretion of the directors who are
neither "interested persons" (as defined in the 1940 Act of the Company nor
have any direct or indirect financial interest in the operation of the
Shareholder Service Plan (or related servicing agreements) (the "Non-Interested
Plan Directors").
The Plan is subject to annual reapproval by a majority of the
Non-Interested Plan Directors and is terminable at any time with respect to the
Fund by a vote of a majority of such
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Directors or by vote of the holders of a majority of the shares of the Fund.
The Company understands that Bank of America, and/or some Service
Organizations may charge their clients a direct fee for administrative and
shareholder services in connection with the holding of Fund shares. These fees
would be in addition to any amounts which might be received under the Plan.
Small, inactive long-term accounts involving such additional charges may not be
in the best interest of shareholders.
The following table shows all sales loads, commissions and other
compensation received by the Distributor directly or indirectly from the Fund
during the fiscal period October 1, 1994 through February 28, 1995:
<TABLE>
<CAPTION>
Brokerage
Commis-
Net Under- sions in
writing Dis- Compensation connection Other
counts and on Redemption with Fund Compen-
Commissions and Repurchase Transactions sation(1)
------------ -------------- ------------ ---------
<S> <C> <C> <C> <C>
Concord Financial
Group, Inc. $1,436 $0 $0 $0
</TABLE>
___________________
(1) Represents the total of (i) amounts paid to the Administrator for
administrative services provided to the Fund (see "Management of the
Company-Administrator" above) and (ii) payments made under the
Shareholder Service Plan (see discussion above).
YIELD AND TOTAL RETURN
From time to time, the yield and the total return of the Fund may
be quoted in and compared to other mutual funds with similar investment
objectives in advertisements, shareholder reports or other communications to
shareholders. The Fund may also include calculations in such communications
that describe hypothetical investment results. (Such performance examples will
be based on an express set of assumptions and are not indicative of the
performance of the Fund.) Such calculations may from time to time include
discussions or illustrations of the effects of compounding in advertisements.
"Compounding" refers to the fact that, if dividends or other distributions on
the Fund investment are reinvested by being paid in additional Fund shares, any
future income or capital appreciation of the Fund would increase the value, not
only of the original Fund investment, but also of the additional Fund shares
received through reinvestment. As a result, the value of the Fund investment
would increase more quickly than if dividends or other distributions had been
paid in cash. The Fund may also include discussions or illustrations of the
potential investment goals of a prospective investor
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<PAGE> 274
(including but not limited to tax and/or retirement planning), investment
management techniques, policies or investment suitability of the Fund, economic
conditions, legislative developments (including pending legislation), the
effects of inflation and historical performance of various asset classes,
including but not limited to stocks, bonds and Treasury bills. From time to
time advertisements or communications to shareholders may summarize the
substance of information contained in shareholder reports (including the
investment composition of the Fund and the Portfolio), as well as the views of
the Portfolio's investment adviser as to current market, economic, trade and
interest rate trends, legislative, regulatory and monetary developments,
investment strategies and related matters believed to be of relevance to the
Fund. The Fund may also include in advertisements charts, graphs or drawings
which illustrate the potential risks and rewards of investment in various
investment vehicles, including but not limited to stocks, bonds, Treasury bills
and shares of the Fund. In addition, advertisements or shareholder
communications may include a discussion of certain attributes or benefits to be
derived by an investment in the Fund and may include testimonials as to the
investment adviser's capabilites by clients. Such advertisements or
communications may include symbols, headlines or other material which highlight
or summarize the information discussed in more detail therein. With proper
authorization, the Fund may reprint articles (or excerpts) written regarding
the Fund and provide them to prospective shareholders. Performance information
with respect to the Fund is generally available by calling (800) 346-2087.
Yield Calculations. The yield of the Fund is calculated by
dividing the net investment income per share (as described below) earned by the
Fund during a 30-day (or one month) period by the maximum offering price per
share on the last day of the period and annualizing the result on a semi-annual
basis by adding one to the quotient, raising the sum to the power of six,
subtracting one from the result and then doubling the difference. The Fund's
net investment income per share earned during the period is based on the
average daily number of shares outstanding during the period entitled to
receive dividends and includes dividends and interest earned during the period
minus expenses accrued for the period, net of reimbursements. This calculation
can be expressed as follows:
a-b
Yield = 2 [(----- + 1)(6) - 1]
cd
Where: a = dividends and interest earned during the period.
b = expenses accrued for the period (net of
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reimbursements).
c = the average daily number of shares outstanding during the
period that were entitled to receive dividends.
d = maximum offering price per share on the last day of the
period.
For the purpose of determining net investment income earned during
the period (variable "a" in the formula), dividend income on equity securities
is recognized by accruing 1/360 of the stated dividend rate of the security
each day. Except as noted below, interest earned on debt obligations is
calculated by computing the yield to maturity of each obligation based on the
market value of the obligation (including actual accrued interest) at the close
of business on the last business day of each month, or, with respect to
obligations purchased during the month, the purchase price (plus actual accrued
interest), and dividing the result by 360 and multiplying the quotient by the
market value of the obligation (including actual accrued interest) in order to
determine the interest income on the obligation for each day of the subsequent
month that the obligation is held. For purposes of this calculation, it is
assumed that each month contains 30 days. The maturity of an obligation with a
call provision is the next call date on which the obligation reasonably may be
expected to be called or, if none, the maturity date. With respect to debt
obligations purchased at a discount or premium, the formula generally calls for
amortization of the discount or premium. The amortization schedule will be
adjusted monthly to reflect changes in the market values of such debt
obligations.
Interest earned on tax-exempt obligations that are issued without
original issue discount and have a current market discount is calculated by
using the coupon rate of interest instead of the yield to maturity. In the
case of tax-exempt obligations that are issued with original issue discount but
which have discounts based on current market value that exceed the
then-remaining portion of the original issue discount (market discount), the
yield to maturity is the imputed rate based on the original issue discount
calculation. On the other hand, in the case of tax-exempt obligations that are
issued with original issue discount but which have the discounts based on
current market value that are less than the then-remaining portion of the
original issue discount (market premium), the yield to maturity is based on the
market value.
With respect to mortgage or other receivables-backed obligations
which are expected to be subject to monthly payments of principal and interest
("pay downs"), (a) gain or loss attributable to actual monthly pay downs are
accounted for as an
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<PAGE> 276
increase or decrease to interest income during the period; and (b) the
Portfolio may elect either (i) to amortize the discount and premium on the
remaining security, based on the cost of the security, to the weighted average
maturity date, if such information is available, or to the remaining term of
the security, if any, if the weighted average maturity date is not available,
or (ii) not to amortize discount or premium on the remaining security.
Undeclared earned income will be subtracted from the maximum
offering price per share (variable "d" in the formula). Undeclared earned
income is the net investment income which, at the end of the base period, has
not been declared as a dividend, but is reasonably expected to be and is
declared and paid as a dividend shortly thereafter. The Fund's maximum
offering price per share for purposes of the formula includes the maximum sales
load imposed by the Fund -- currently 4.50% of the per share offering price.
Based on the foregoing calculations, the yield (after fee waivers
and expense reimbursements) for the 30 day period ended February 28, 1995 was
6.72%.
Total Return Calculations. The Fund may compute its average
annual total return by determining the average annual compounded rates of return
during specified periods that equate the initial amount invested to the ending
redeemable value of such investment. This is done by dividing the ending
redeemable value of a hypothetical $1,000 initial payment by $1,000 and raising
the quotient to a power equal to one divided by the number of years (or
fractional portion thereof) covered by the computation and subtracting one from
the result. This calculation can be expressed as follows:
ERV 1/n
T = [(-----) - 1]
P
Where: T = average annual total return.
ERV = ending redeemable value at the end of the period
covered by the computation of a hypothetical $1,000
payment made at the beginning of the period.
P = hypothetical initial payment of $1,000.
n = period covered by the computation, expressed in
terms of years.
The Fund computes its aggregate total return by determining the
aggregate rate of return during specified periods
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<PAGE> 277
that likewise equates the initial amount invested to the ending redeemable
value of such investment. The formula for calculating aggregate total return
is as follows:
ERV
aggregate total return = [(----- - 1)]
P
The calculations of average annual total return and aggregate
total return assume the reinvestment of all dividends and capital gain
distributions on the reinvestment dates during the period. The ending
redeemable value (variable "ERV" in each formula) is determined by assuming
complete redemption of the hypothetical investment and the deduction of all
nonrecurring charges at the end of the period covered by the computations. In
addition, the Fund's average annual total return and aggregate total return
quotations reflect the deduction of the maximum sales load charged in connection
with the purchase of Fund shares.
Based on the foregoing calculations, the respective average annual
total return and aggregate total returns: for the Fund for the period from
October 1, 1994 through February 28, 1995 and for the period from October 1,
1994 through February 28, 1995 and for the period April 25, 1994 (the date the
Predecessor Fund was reorganized into the Fund) through February 28, 1995 were
N/A and 4.25%, and N/A% and 4.66%, respectively; for the Predecessor Fund for
the one, five and ten-year periods ended April 24, 1994 were 1.92% and 1.92%,
8.71% and 51.41%, and 11.79% and 203.74%, respectively; and for the Predecessor
Fund for the one, five and ten-year periods ended September 30, 1993 were
14.30% and 14.30%, 10.79% and 67.00%, and 11.15% and 188.02%, respectively.
The Fund may advertise total return data without reflecting the
sales load imposed on the purchase of shares of the Fund in accordance with the
rules of the Securities and Exchange Commission. Quotations which do not
reflect the sales load will, of course, be higher than quotations which do.
GENERAL INFORMATION
DESCRIPTION OF SHARES
The Company is an open-end management investment company organized
as a Maryland corporation on October 27, 1982. The Fund's Charter authorizes
the Board of Directors to issue up to two hundred billion full and fractional
common shares. Pursuant to the authority granted in the Charter, the Board of
Directors has authorized the issuance of twenty-two classes of stock - Classes
A through W Common Stock, $.001 par value per
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<PAGE> 278
share, representing interests in twenty-two separate investment portfolios.
Class W represents interests in the Corporate Bond Fund. The Company's charter
also authorizes the Board of Directors to classify or reclassify any particular
class of the Company's shares into one or more series.
Shares have no preemptive rights and only such conversion or
exchange rights as the Board may grant in its discretion. When issued for
payment as described in the Prospectus, the Company's shares will be fully paid
and non-assessable. For information concerning possible restrictions upon the
transferability of the Company's shares and redemption provisions with respect
to such shares, see "Additional Purchase and Redemption Information."
Shareholders are entitled to one vote for each full share held,
and fractional votes for fractional shares held, and will vote in the aggregate
and not by class or series except as otherwise required by the 1940 Act or other
applicable law or when permitted by the Board of Directors. Shares have
cumulative voting rights to the extent they may be required by applicable law.
Rule 18f-2 under the 1940 Act provides that any matter required to
be submitted to the holders of the outstanding voting securities of an
investment company such as the Company shall not be deemed to have been
effectively acted upon unless approved by a majority of the outstanding shares
of each fund affected by the matter. The Fund is affected by a matter unless
it is clear that the interests of each fund in the matter are substantially
identical or that the matter does not affect any interest of such portfolio.
Under Rule 18f-2 the approval of an investment advisory agreement or 12b-1
distribution plan or any change in a fundamental investment policy would be
effectively acted upon with respect to a portfolio only if approved by a
majority of the outstanding shares of such Portfolio. However, the rule also
provides that the ratification of independent public accountants, the approval
of principal underwriting contracts and the election of directors may be
effectively acted upon by shareholders of the Company voting without regard to
particular funds.
Notwithstanding any provision of Maryland law requiring a greater
vote of the Company's common stock (or of the shares of the Fund voting
separately as a class) in connection with any corporate action, unless
otherwise provided by law (for example, by Rule 18f-2 discussed above) or by
the Company's Charter, the Company may take or authorize such action upon the
favorable vote of the holders of more than 50% of the outstanding common stock
of the Company voting without regard to class.
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<PAGE> 279
THE PORTFOLIO
The Portfolio is a separate series of Master Investment Trust,
Series I, which was organized on October 26, 1992 as a Delaware business trust.
The Master Trust's Declaration of Trust authorizes its Board of Trustees to
issue an unlimited number of interests of beneficial interest and to establish
and designate any unissued interests of one or more additional series of
interests. Investors in the Portfolio are entitled to distributions arising
from the net investment income and net realized gains, if any, earned on
investments held by the Portfolio. Investors are also entitled to participate
in the net distributable assets of the Portfolio on liquidation. Beneficial
interests have no preemptive, conversion or exchange rights.
CUSTODIAN, ACCOUNTING AGENT AND TRANSFER AGENT
PNC Bank, National Association ("PNC") has been appointed
custodian for the Fund and the Portfolio. PFPC, Inc. ("PFPC"), 103 Bellevue
Parkway, Wilmington, DE 19809, provides the Fund with certain accounting
services pursuant to Fund Accounting Services Agreements with the Administrator.
Both PNC and PFPC are wholly-owned subsidiaries of PNC Bancorp, Inc., a bank
holding company. Under the Fund Accounting Services Agreement, PFPC has agreed
to provide certain accounting, bookkeeping, pricing, dividend and distribution
calculation services with respect to the Company and the Portfolio. The monthly
fees charged by PFPC under the Fund Accounting Agreements are borne by the Fund
and the Portfolio. As custodian of the assets of the Fund and the Portfolio,
PNC: (i) maintains a separate account or accounts in the name of the Fund and
Portfolio (as applicable); (ii) holds and disburses portfolio securities; (iii)
makes receipts and disbursements of money; (iv) collects and receives income and
other payments and distributions on account of portfolio securities; (v)
responds to correspondence from security brokers and others relating to its
respective duties; and (vi) makes periodic reports concerning its respective
duties.
BISYS Fund Services Ohio, Inc., 3435 Stelzer Road, Columbus, Ohio
43219-3035 serves as transfer and dividend disbursing agent for the Fund.
COUNSEL
Drinker Biddle & Reath (of which W. Bruce McConnel, III, Secretary
of the Company, is a partner), 1345 Chestnut Street, Suite 1100, Philadelphia,
Pennsylvania 19107, serves as counsel to the Company and the Master Trust and
will pass upon certain legal matters on their behalf.
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<PAGE> 280
INDEPENDENT ACCOUNTANTS
Price Waterhouse LLP with offices at 1177 Avenue of the Americas,
New York, New York 10036, has been selected as independent accountants of the
Fund and for the Portfolio.
REPORTS
Shareholders receive unaudited semi-annual reports describing the
Portfolio's and the Fund's investment operations and annual financial
statements together with the reports of the independent accountants of the
Portfolio and the Fund.
MISCELLANEOUS
As used in the Prospectus and this Statement of Additional
Information, a "vote of a majority" of the outstanding interests of the
Portfolio, the outstanding shares of the Fund or a particular series means the
affirmative vote of the lesser of (a) more than 50% of the outstanding
interests of the Portfolio, Fund or such series, or (b) 67% of the interests
of the Portfolio, the shares of the Fund or such series present at a meeting at
which more than 50% of the outstanding interests of the Portfolio, the
outstanding shares of the Fund or series are represented in person or by proxy.
At June 15, 1995, the name, address and share ownership of the
entities which held of record more than 5% of the oustanding Pacific Horizon
Shares of the Treasury Fund were as follows: BA Investment Services, Inc., For
the Benefit of clients, 555 California Street, 4th Floor, Department #4337, San
Francisco, CA 94104, 98,230,626.530 shares (7.70%); Bank of America State
Trust Co., 299 N. Euclid Avenue, Pasadena, CA l91101, 1,044,975,154.790 shares
(82.00%); and Hellman & Friedman Capital Partners II, Limited Partnership,
Attention: Georgia Lee, 1 Maritime Plaza, 12th Floor, San Francis, CA 94111,
1,216,118,073.700 shares (095.42%).
At June 15, 1995, the name, address and share ownership of the
entities which held of record more than 5% of the outstanding Pacific Horizon
Shares of the Treasury Fund were as follows: BA Investment Services Inc., For
the Benefit of Clients, 555 California Street, 4th Floor, Department #4337, San
Francisco, CA 94104, 98,230,626.530 shares (7.70%); Bank of America State Trust
Co., 299 N. Euclid Avenue, Pasadena, CA 91101, 1,044,975,154.790 shares
(82.00%); and Hellman & Freidman Capital Partners II, Limited Partnership,
Attention: Georgia Lee, 1 Maritime Plaza, 12th Floor, San Francisco, CA 94111,
1,216,118,073.700 shares (095.42%).
At June 16, 1995, the name, address and share ownership of the
entities which held of record more than 5% of the
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<PAGE> 281
outstanding Horizon Shares of the Treasury Fund was as follows: Bank of
America Trustee/Custodian for Investing in Horizon Treasury, Attn: Eric
Peterson, 701 S. Western Avenue, 2nd Floor, Glendale, CA 91201, 398,540,438.170
shares (68.901%); Security Pacific State Trust Co., Agreement for Sec. PACWA
Participants, Attn: Cash Sweep Funds (L. Goekjian), P.O. Box 91630, Pasadena,
CA 91101, 94,279,024.120 shares (16.299%).
At June 16, 1995, the name, address and share ownership of the
entities which held beneficially more than 5% of the outstanding Horizon
Service Shares of the Treasury Fund were as follows: Bank of America FM&TS
Operat CA, Attn: CTF Unit, 701 South Western Avenue, Glendale, CA 91201,
65,745,555.320 shares (23.658%); Bank of America Nevada Southern Comm. Bank,
Attn: Dan Dykes, P.O. Box 98600, Las Vegas, NV 89193, 63,974,589.270 shares
(23.020%). Security Pacific State Trust Co., Agreement for Sec. PACWA
Participants, Attn: Cash Sweep Funds, P.O. Box 91630, Pasadena, CA 91101,
56,906,301.540 shares (20.477%); and Security Pacific Cash Management, c/o Bank
of America - GPO M/C 5533, Attn: Liezel Barangan, 1850 Gateway Boulevard,
Concord, CA 94520, 77,003,300 shares (27.709%). At June 15, 1995, the name,
address and, share ownership of the entity which held of record more than 5% of
the outstanding Horizon Service Shares of the Treasury Fund was as follows:
Omnibus A/C for the Shareholder Accounts maintained by Concord Financial
Services, Inc., Attn: Linda Zerbe, First and Market Building, 100 First Avenue,
Suite 300, Pittsburgh, PA 15222, 263,629,755.130 shares (65.51%). At June 15,
1995 the name, address and share ownership of the entities which held of record
more than 5% of the outstanding Pacific Horizon Shares of the Prime Fund were
as follows: BA Investment Services Inc., For the Benefit of Clients, 555
California Street, 4th Floor, Department #4337, San Francisco, CA 94104,
514,119,226.900 shares (38.76%); Bank of America State Trust Co., 299 N. Euclid
Avenue, Pasadena, CA 91101, 392,983,248.780 shares (29.63%); and Southwest
Securities Inc., Attn: Cashiering, 201 Elm Street, Suite 4300, Dallas, TX
75270, 169,018,910.270 shares (12.74%). At June 16, 1995, the name, address
and share ownership of the entities which held of record more than 5% of the
outstanding Horizon Shares of the Prime Fund were as follows: Bank of America
Trustee/Custodian for Investing Horizon Prime, Attn: Eric Peterson, 701 S.
Western Avenue, 2nd Floor, Glendale, CA 91201, 385,058,852.030 shares
(56.838%); and Bank of America NT&SA, Attn: Kay Warren/Dept. #5596, 1455 Market
Street, San Francisco, CA 94103, 57,300,000.00 shares (9.934%). At June 15,
1995, the name, address and share ownership of the entity which held of record
more than 5% of the outstanding Horizon Service Shares of the Prime Fund were
as follows: Omnibus A/C for the Shareholder Accounts maintained by Concord
Financial Services, Inc., Attn: Linda Zerbe, First and Market Building, 100
First Avenue, Suite 300, Pittsburgh, PA 15222, 752,776,315.610 shares (70.26%).
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At June 16, 1995, the name, address and share ownership of the
entities which held beneficially more than 5% of the outstanding Horizon
Service Shares of the Prime Fund were as follows: Bank of America NT&SA
Financial Management and Trust Services, 701 S. Western Avenue, Glendale, CA
91201, 74,038,082.090 shares (9.835%); Capital Network Services, Attn: Donna
Novell, One Bush Street, 11th Floor, San Francisco, CA 94104, 86,407,261.23
shares (11.478%); Security Pacific Cash Management, c/o Bank of America. GPO.
M/C 5533 Attn: Liezel Barangan, 1850 Gateway Boulevard, M/C 5533, Concord, CA
94520, 379,755,600.000 shares (50.447%); Security Pacific State Trust Co.,
Agreement for SecPAC WA Participants, Attn: Cash Sweep Funds (L. Goekjian) P.O.
Box 91630, Pasadena, CA 91101, 54,321,621.330 shares (7.216%); and Southwest
Securities Inc., Attn: Mary Lisenber, 1201 Elm Street, Suite 4300, Dallas, TX
75270, 130,146,660.030 shares (17.289%).
At June 15, 1995, the name, address and share ownership of the
entities which held of record more than 5% of the outstanding Pacific Horizon
Shares of the Tax-Exempt Money Fund were as follows: BA Investment Services,
Inc., For the Benefit of Clients, 555 California Street, 4th Floor, Department
#4337, San Francisco, CA 94104, 12,233,845.190 shares (39.73%); Southwest
Securities Inc., Attn: Cashiering, 1201 Elm Street, Suite 4300, Dallas, TX,
75270, 10,387,253.930 shares (33.73%); and Bank of America State Trust Co., 299
N. Euclid Avenue, Pasadena, CA 91101, 6,515,635.730 shares (21.16%).
At June 16, 1995, the name, address and share ownership of the
entities which held of record more than 5% of the outstanding Horizon Shares of
the Tax-Exempt Money Fund were as follows: Bank of America Custodian For
Investing in Horizon Tax- Exempt Money Fund, Attn: Eric Peterson, 701 S.
Western Avenue, 2nd Floor, Glendale, CA 19201, 129,582,555.65 shares (38.576%);
Continental Bank National Association Custodian for the Benefit of Custodian
Co. Attn: Mary Chester, 231 South LaSalle Street, 6Q, Chicago, IL 60697,
152,699,416.270 shares (45.458%); and Maine Midland Bank NA, Investment
Services, 17th Floor, Attn: Christine Mincel, One Marine Midland Center,
Buffalo, NY 14203, 21,684,672.980 shares (6.455%).
At June 15, 1995, the name, address and share ownership of the
entities which held of record more than 5% of the outstanding shares of the
Horizon Service Shares of the Tax-Exempt Money Fund were as follows: Furman C.
Moseley and Susan R. Moseley Tenn. In Common, 1201 3rd Avenue, Box 7C,
Seattle, WA 98101, 4,165,513.060 shares (9.91%); Omnibus A/C for the
shareholder accounts maintained by Concord Financial Services Inc., Attn: Linda
Zerbe, First and Market Building, 100 First Avenue, Suite 300, Pittsburgh, PA
15222, 22,398,544.590 shares (53.31%); and Omnibus A/C for the Shareholder
Accounts maintained by Concord Financial Services Inc. Attn: First and Market
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Building, 100 First Avenue, Suite 300, Pittsburgh, PA 15222, 3,494,305.180
shares (8.31%). At June 16, 1995, the name, address and share ownership of the
entities which held beneficially more than 5% of the outstanding Horizon
Service Shares of the Tax-Exempt Money Fund were as follows: BA Investment
Services Inc., 555 California Street, 4th Floor Dept. #4337, San Francisco, CA
94104, 1,362,028.590 shares (5.260%); Bank of America FM&TS Oper. CA, Attn: CTF
Unit, 701 South Western Avenue, Glendale, CA 91201, 2,293,907.40 shares
(8.859%); and Southwest Securities, Inc., Attn: Mary Lisenber, 1201 Elm Street,
Suite 430, Dallas, TX 75270, 21,021,580.530 shares (81.187%). At June 15,
1955, the name, address and share ownership of the entities which held of
record more than 5% of the outstanding Pacific Horizon Shares of the Government
Fund were as follows: Bank of America, NT&SA, The Private Bank, Attn: ACI Unit
#8329, 701 S. Western Avenue, Glendale, CA 91201, 79,875,532.090 shares
(22.71%); Bank of America State Trust Co., 299 N. Euclid Avenue., Pasadena, CA
91101, 64,756,966.280 shares (18.41%); and BA Investment Services Inc., For the
Benefit of Clients, 555 California Street, 4th Floor, Department #4337, San
Francisco, CA 94104, 170,940,404.650 shares (48.60%). At June 16, 1995, the
name, address and share ownership of the entities which held of record more
than 5% of the outstanding Horizon Shares of the Government Fund were as
follows: Bank of America NT&SA Trustee/Custodian for Investing in Horizon
Shares of the Government Fund, Attn: Cynthia Beauvais, 701 South Western
Avenue., Glendale, CA 91201, 9,327,446.350 shares (5.028%); Bank of America
State Trust, Attn: Rigo Barrett, 299 N. Euclid Avenue, Pasadena, CA 91101,
28,063,486.740 shares (15.129%); Capital Network Services, Attn: Donna Novell,
One Bush Street, 11th Floor, San Francisco, CA 94104, 24,227,801.980 shares
(13.061%); County of Orange, Matt Raabe, P.O. Box 4515, Santa Ana, CA 92702,
10,000,000.000 shares (5.391%); Cypress Insurance Co., Attn: Larry Tetzloff,
9290 W. Dodge Road, Omaha, NE 68124, 9,996,515.930 shares (5.389%); Harr &
Co., c/o Bank of New York, Attn: Bimal Sana, Spec. Prec. Dept., One Wall
Street, 5th Floor, New York, NY 10286, 14,000,000.000 shares (7.547%); Micron
Electronics Inc., Attn: Debbie Meigand, 900 East Karcher Road, Nanpa, ID 83687,
16,080,510.14 shares (8.669%); and Silocin Magic Corp., Attn: Meng A. Lim,
20300 Stevens Creek Boulevard., Suite 400, Cupertino, CA 95014, 18,058,262.110
shares (9.735%). At June 15, 1995, the name, address and share ownership of
the entities which held of record more than 5% of the outstanding Horizon
Service Shares of the Government Fund were as follows: Spacelabs Medical, Inc.,
Attn: Scott Bender, P.O. Box 97013, Redmond, WA 98073, 14,572,000.000 shares
(5.70%); Good Health Plan of WA, Attn: Tsai Cheng, 1501 9th Avenue, Suite 500,
Seattle, WA 98101, 16,584,866.580 shares (6.49%); Omnibus A/C for the
Shareholder Accounts maintained by Concord. Financial Services Inc., Attn:
Linda Zerbe, First and Market Building, 100 First Avenue, Suite 300,
Pittsburgh, PA 15222, 68,555,257.020 shares (26.85%). At June 16, 1995, the
name, address and share
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ownership of the entities which held beneficially more than 5% of the Horizon
Service Shares of the Government Fund were as follows: Bank of America Nevada
Southern Comm. Bank, Attn: Dan Dykes, P.O. Box 98600, Las Vegas, NV 89193-8600,
35,849,966.050 shares (52.294%); and Capital Network Services, Attn: Donna M.
Howell, One Bush Street, 11th Floor, San Francisco, CA 94104-4425,
23,929,840.440 shares (34.906%). At June 15, 1995, the name, address and share
ownership of the entities which held of record more than 5% of the Pacific
Horizon Shares of the Treasury Only Fund were as follows: Bank of America
NT&SA, the Private Bank, Attn: ACI Unit 48329, 701 South Western Avenue,
Glendale, CA 91201, 48,516,900.490 shares (31.68%) Bank of America State Trust
Co., 299 N. Euclid Avenue, Pasadena, CA 91101, 22,350,831.320 shares (14.59%);
and BA Investment Services Inc., For the Benefit of Clients, 555 California
Street, 4th Floor, Department #4337, San Francisco, CA 94104, 69,016,521.500
shares (45.06%). At June 15, 1995, the name, address and share ownership of
the entities which held of record more than 5% of the outstanding Horizon
Service Shares of the Treasury Only Fund were as follows: National Home
Mortgage Corp., Attn: Mortgage Banking Treasury Operations, 5565 Morehouse
Drive, 3rd Floor, San Diego, CA 92121, 12,147.667,580 shares (9.42%); Comcare,
Inc., 4001 N. 3rd Street, Suite 120, Phoenix, AZ 85012, 26,230,243.620 shares
(20.34%); and Omnibus A/C For the Shareholder Accounts Maintained by Concord
Financial Services Inc., Attn: Linda Zerbe, First and Market Building, 100
First Avenue, Suite 300, Pittsburgh, PA 15222, 21,883,084.450 shares (16.97%).
At June 16, 1995, the name, address and share ownership of the entities which
held beneficially more than 5% of the outstanding Horizon Service Shares of the
Treasury Only Fund were as follows: BA Investment Service Inc., 555 California
Street, 4th Floor Dept. #4337, San Francisco, CA 94104, 6,403,628.120 shares
(28.679%); Bank of America NT&SA Trustee/Custodian for Investing in Horizon
Service Shares of the Treasury Only Fund, Attn: Cynthia Beauvais, 701 South
Western Avenue, Glendale, CA 91201, 3,501,414.020 shares (15.681%); Bank of
America State Trust, Attn: Rigo Barrett, 299 N. Euclid Avenue, Pasadena, CA
91101, 5,420,893.150 shares (24.277%); Fair Isaac & Co., Attn: Christine Tam,
120 North Redwood, San Rapheal, CA 94903-1996, 1,338,800.750 shares (5.996%);
Foothill/Eastern Transportation Corridor Agency, Attn: Laura Barker, 201 East
Sandpot, Suite 200, Santa Anna, CA 92707, 2,559,586.380 shares (11.463%); and
Nexus, Attn: Kathleen Menace, P.O. Box 60637, Sunnyvale, CA 94088-0637,
2,525,153.380 shares (11.309%). At June 15, 1995, the name, address and share
ownership of the entities which held of record more than 5% of the outstanding
Pacific Horizon Shares of the Prime Value Fund were as follows: BA Investment
Services Inc., For the Benefit of Clients, 555 California Street, 4th Floor,
Department #4337, San Francisco, CA 94104, 16,383,467.170 shares (26.45%); and
Bank of America State Trust Co., Attn: Leon Goekjian, P.O. Box 91630, Pasadena,
CA 91101, 45,078,465.290 shares (72.79%). At June 16, 1995, the name, address
and share ownership of the entity which
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held of record more than 5% of the outstanding Horizon Shares of the Prime
Value Fund was as follows: Tice & Co., c/o M&T, Attn: Cash Management Clerk,
8th Floor, P.O. Box 1377, Buffalo, NY 14240, 453,078,561.590 shares (93.510%).
At June 15, 1995, the name, address and share ownership of the entity which
held of record more than 5% of the outstanding shares of the Pacific Horizon
Shares of the California Tax-Exempt Money Market Fund was as follows: BA
Investment Services Inc., For the Benefit of Clients, 555 California Street,
4th Floor, Department #4337, San Francisco, CA 94104, 204,443,886.590 shares
(22.07%). At June 15, 1995, the name, address and share ownership of the
entities which held of record more than 5% of the outstanding shares of the
Horizon Service Shares of the California Tax-Exempt Money Market Fund were as
follows: Leo Zuckerman Trust, DTD 12-11-91,4444 Viewridge Avenue, San Diego,
CA 92123, 4,850,877.280 shares (5.35%); and Omnibus A/C for the Shareholder
Accounts Maintained by Concord Financial Services Inc. Attn: Linda Zerbe, First
and Market Building, 100 First Avenue, Suite 300, Pittsburgh, PA 15222,
13,391,453.970 shares (14.77%). At June 16, 1995, the name, address and share
ownership of the entity which held beneficially more than 5% of the outstanding
shares of the Horizon Service Shares of the California Tax-Exempt Money Market
Fund was as follows: BA Investment Services Inc., 555 California Street, 4th
Floor, Dept. #4337, San Francisco, CA 94109, 13,792,509.310 shares (99.206%).
At June 15, 1995, the name, address and shares ownership of the entities which
held of record more than 5% of the outstanding shares of the Flexible Bond Fund
were as follows: Peter F. Smith and Jacquelyn L. Smith, JTWROS, 1785 C.
Blodgett Road, Mount Vernon, WA 98273, 13,973.917 shares (5.58%); and BA
Investment Services, Inc., FBO 200724011, 185 Berry Street, 3rd Floor #2640,
San Francisco, CA 94104, 22,436.531 shares (8.96%). At June 15, 1995 the name,
address and share ownership of the entity which held of record more than 5% of
the outstanding shares of the Asset Allocation Fund was as follows: Bank of
America, Texas AATTEE. National-O'Neill Supplemental Savings Plan, Attn:
Mutual Funds (81-6-01005-0), P.O. Box 94627, Pasadena, CA 91109, 24,289,973
shares (5.07%). At June 15, 1995 the name, address and share ownership of the
entities which held of record more than 5% of the outstanding shares of the
National Municipal Bond Fund were as follows: BA Investment Services, Inc. FBO
405084421, 555 California Street, 4th Floor, #2640, San Francisco, CA 94104,
26,336.154 shares (8.31%); and BA Investment Services, Inc., FBO 405266591, 555
California Street, 4th Floor, #2640, San Francisco, CA 94104, 25,034.024 shares
(7.90%). At June 15, 1995 the name, address and share ownership of the
entities which held of record more than 5% of the outstanding shares of the
Corporate Bond Fund were as follows: Dean Witter Reynolds Inc., 5 World Trade
Center, 4th Floor, Attn: 5th O Div., New York, NY 10048, 138,820.000 shares
(6.93%); and Smith Barney Shearson, Inc., 333 W. 39th Street, 8th Floor, New
York, NY 10001, 148,925.482 shares (7.43%).
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At such date, no other person was known by the Company to hold of
record or beneficially more than 5% of the outstanding shares of any other
investment portfolio of the Company.
The Prospectus relating to the Fund and this Statement of
Additional Information omit certain information contained in the Company's
registration statement filed with the SEC. Copies of the registration
statement, including items omitted herein, may be obtained from the Commission
by paying the charges prescribed under its rules and regulations.
FINANCIAL STATEMENTS AND EXPERTS
The Annual Report for the Fund and the Portfolio for the fiscal
period ended February 28, 1995 accompanies this Statement of Additional
Information. The financial statements and notes thereto in that Annual Report
are incorporated in this Statement of Additional Information by reference, and
have been audited by Price Waterhouse LLP, whose report thereon also appears in
such Annual Report and is also incorporated herein by reference. Such
financial statements have been incorporated herein in reliance on the report of
Price Waterhouse LLP, independent accountants, given on the authority of said
firm as experts in auditing and accounting.
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APPENDIX A
COMMERCIAL PAPER RATINGS
A Standard & Poor's commercial paper rating is a current
assessment of the likelihood of timely payment of debt considered short-term in
the relevant market. The following summarizes the rating categories used by
Standard and Poor's for commercial paper:
"A-1" - Issue's degree of safety regarding timely payment is
strong. Those issues determined to possess extremely strong safety
characteristics are denoted "A-1+."
"A-2" - Issue's capacity for timely payment is satisfactory.
However, the relative degree of safety is not as high as for issues designated
"A-1."
"A-3" - Issue has an adequate capacity for timely payment. It is,
however, somewhat more vulnerable to the adverse effects of changes and
circumstances than an obligation carrying a higher designation.
"B" - Issue has only a speculative capacity for timely payment.
"C" - Issue has a doubtful capacity for payment.
"D" - Issue is in payment default.
Moody's commercial paper ratings are opinions of the ability of
issuers to repay punctually promissory obligations not having an original
maturity in excess of 9 months. The following summarizes the rating categories
used by Moody's for commercial paper:
"Prime-1" - Issuer or related supporting institutions are
considered to have a superior capacity for repayment of short- term promissory
obligations. Prime-1 repayment capacity will normally 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.
"Prime-2" - Issuer or related supporting institutions are
considered to have a strong capacity for repayment of short-
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term promissory 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 alternative liquidity is maintained.
"Prime-3" - Issuer or related supporting institutions have an
acceptable capacity for repayment of short-term promissory obligations. The
effects of industry characteristics and market composition may be more
pronounced. Variability in earnings and profitability may result in changes in
the level of debt protection measurements and the requirement for relatively
high financial leverage. Adequate alternate liquidity is maintained.
"Not Prime" - Issuer does not fall within any of the Prime rating
categories.
The three rating categories of Duff & Phelps for investment grade
commercial paper and short-term debt are "Duff 1," "D-2" and "D-3." D-&
Phelps employs three designations, "D-1+," "D-1" and "D-1-," within the highest
rating category. The following summarizes the rating categories used by D-&
Phelps for commercial paper:
"D-1+" - Debt possesses 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 issue as investment grade. Risk factors are larger
and subject to more variation. Nevertheless, timely payment is expected.
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"D-4" - Debt possesses speculative investment characteristics.
Liquidity is not sufficient to ensure 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 short-term ratings apply to debt obligations that are
payable on demand or have original maturities of up to three years. The
following summarizes the rating categories used by Fitch for short-term
obligations:
"F-1+" - Securities possess exceptionally strong credit quality.
Issues assigned this rating are regarded as having the strongest degree of
assurance for timely payment.
"F-1" - Securities possess very strong credit quality. Issues
assigned this rating reflect an assurance of timely payment only slightly less
in degree than issues rated "F-1+."
"F-2" - Securities possess good credit quality. Issues assigned
this rating have a satisfactory degree of assurance for timely payment, but the
margin of safety is not as great as the "F-1+" and "F-1" categories.
"F-3" - Securities possess fair credit quality. Issues assigned
this rating have characteristics suggesting that the degree of assurance for
timely payment is adequate; however, near-term adverse changes could cause
these securities to be rated below investment grade.
"F-S" - Securities possess weak credit quality. Issues assigned
this rating have characteristics suggesting a minimal degree of assurance for
timely payment and are vulnerable to near-term adverse changes in financial and
economic conditions.
"D" - Securities are in actual or imminent payment default.
Fitch may also use the symbol "LOC" with its short-term ratings to
indicate that the rating is based upon a letter of credit issued by a commercial
bank.
Thomson BankWatch short-term ratings assess the likelihood of an
untimely or incomplete payment of principal or interest of unsubordinated
instruments having a maturity of one year or less which is issued by United
States commercial banks, thrifts and non-bank banks; non-United States banks;
and broker-
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dealers. The following summarizes the ratings used by Thomson BankWatch:
"TBW-1" - This designation represents Thomson BankWatch's highest
rating category and indicates a very high degree of likelihood that principal
and interest will be paid on a timely basis.
"TBW-2" - This designation indicates that while the degree of
safety regarding timely payment 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 the lowest investment grade
category and indicates that while the debt is more susceptible to adverse
developments (both internal and external) than obligations with higher ratings,
capacity to service principal and interest in a timely fashion is considered
adequate.
"TBW-4" - This designation indicates that the debt is regarded as
non-investment grade and therefore speculative.
IBCA assesses the investment quality of unsecured debt with an
original maturity of less than one year which is issued by bank holding
companies and their principal bank subsidiaries. The following summarizes the
rating categories used by IBCA for short-term debt ratings:
"A1" - Obligations are supported by the highest capacity for
timely repayment. Where issues possess a particularly strong credit feature, a
rating of A1+ is assigned.
"A2" - Obligations are supported by a good capacity for timely
repayment.
"A3" - Obligations are supported by a satisfactory capacity for
timely repayment.
"B" - Obligations for which there is an uncertainty as to the
capacity to ensure timely repayment.
"C" - Obligations for which there is a high risk of default or
which are currently in default.
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CORPORATE AND MUNICIPAL LONG-TERM DEBT RATINGS
The following summarizes the ratings used by Standard & Poor's for
corporate and municipal debt:
"AAA" - This designation represents the highest rating assigned by
Standard & Poor's to a debt obligation and indicates an extremely strong
capacity to pay interest and repay principal.
"AA" - Debt is considered to have a very strong capacity to pay
interest and repay principal and differs from AAA issues only in small degree.
"A" - Debt is considered to have a strong capacity to pay interest
and repay principal although such issues are somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than debt
in higher-rated categories.
"BBB" - Debt is regarded as having an adequate capacity to pay
interest and repay principal. Whereas such issues normally exhibit adequate
protection parameters, adverse economic conditions or changing circumstances
are more likely to lead to a weakened capacity to pay interest and repay
principal for debt in this category than in higher-rated categories.
"BB," "B," "CCC," "CC" and "C" - Debt is regarded, on balance, as
predominantly speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligation. "BB" indicates the
lowest degree of speculation and "C" the highest degree of speculation. While
such debt will likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major risk exposures to adverse
conditions.
"BB" - Debt has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure
to adverse business, financial or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. The "BB"
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied "BBB-" rating.
"B" - Debt has a greater vulnerability to default but currently
has the capacity to meet interest payments and principal repayments. Adverse
business, financial or economic conditions will likely impair capacity or
willingness to pay interest and repay principal. The "B" rating category is
also used for debt subordinated to senior debt that is assigned an actual or
implied "BB" or "BB-" rating.
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"CCC" - Debt has a currently identifiable vulnerability to
default, and is dependent upon favorable business, financial and economic
conditions to meet timely payment of interest and repayment of principal. In
the event of adverse business, financial or economic conditions, it is not
likely to have the capacity to pay interest and repay principal. The "CCC"
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied "B" or "B-" rating.
"CC" - Debt is typically applied to debt subordinated to senior
debt that is assigned an actual or implied "CCC" rating.
"C" - Debt is typically applied to debt subordinated to senior
debt which is assigned an actual or implied "CCC-" debt rating. The "C" rating
may be used to cover a situation where a bankruptcy petition has been filed, but
debt service payments are continued.
"CI" - This rating is reserved for income bonds on which no
interest is being paid.
"D" - Debt is in payment default and is used when interest
payments or principal payments are not made on the date due, even if the
applicable grace period has not expired, unless S & P believes such payments
will be made during such grace period. "D" rating is also used upon the filing
of a bankruptcy petition if debt service payments 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 rating is attached to highlight derivative, hybrid, and
certain other obligations that S & P believes may experience high volatility or
high variability in expected returns due to non-credit risks. Examples of such
obligations are: securities whose principal or interest return is indexed to
equities, commodities, or currencies; certain swaps and options; and interest
only and principal only mortgage securities.
The following summarizes the ratings used by Moody's for corporate
and municipal long-term debt:
"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.
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"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 risks appear somewhat larger than in "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 considered medium-grade obligations, i.e., they are
neither highly protected nor poorly secured. Interest payments and principal
security appear adequate for the present but certain protective elements may be
lacking or may be characteristically unreliable over any 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 some speculative elements; "B" indicates a general lack of
characteristics of desirable investment; "Caa" represents a 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 (a) earnings of projects under
construction, (b) earnings of projects unseasoned in operation experience, (c)
rentals which begin when facilities are completed, or (d) payments to which
some other limiting condition attaches. Parenthetical rating denotes probable
credit stature upon completion of construction or elimination of basis of
condition.
Moody's applies numerical modifiers 1, 2 and 3 in each generic
classification from "Aa" to "B" in its bond rating system. The modifier 1
indicates that the company ranks in the higher end of its generic rating
category; the modifier 2 indicates a mid-range ranking; and the modifier 3
indicates that the issue ranks at the lower end of its generic rating category.
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The following summarizes the long-term debt ratings used by Duff &
Phelps 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 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 and greater in periods of
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 highest four ratings used by Fitch
for corporate and municipal bonds:
"AAA" - Bonds considered to be investment grade and of the highest
credit quality. The obligor has an exceptionally strong ability to pay
interest and repay principal, which is unlikely to be affected by reasonably
foreseeable events.
"AA" - Bonds considered to be investment grade and of very high
credit quality. The obligor's ability to pay interest and repay principal is
very strong, although not quite as strong as bonds rated "AAA." Because bonds
rated in the "AAA" and "AA" categories are not significantly vulnerable to
foreseeable future developments, short-term debt of these issuers is generally
rated "F-1+."
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"A" - Bonds considered to be investment grade and of high credit
quality. The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse changes in
economic conditions and circumstances than bonds with higher ratings.
"BBB" - Bonds considered to be investment grade and of
satisfactory credit quality. The obligor's ability to pay interest and repay
principal is considered to be adequate. Adverse changes in economic conditions
and circumstances, however, are more likely to have an adverse impact on these
bonds, and therefore, impair timely payment. The likelihood that the ratings of
these bonds will fall below investment grade is higher than for bonds with
higher ratings.
"BB," "B," "CCC," "CC," "C," "DDD," "DD," and "D" - Bonds that
possess one of these ratings are considered by Fitch to be speculative
investments. The ratings "BB" to "C" represent Fitch's assessment of the
likelihood of timely payment of principal and interest in accordance with the
terms of obligation for bond issues not in default. For defaulted bonds, the
rating "DDD" to "D" is an assessment of the ultimate recovery value through
reorganization or liquidation.
To provide more detailed indications of credit quality, the Fitch
ratings from and including "AA" to "C" may be modified by the addition of a
plus (+) or minus (-) sign to show relative standing within these major rating
categories.
IBCA assesses the investment quality of unsecured debt with an
original maturity of more than one year which is issued by bank holding
companies and their principal bank subsidiaries. The following summarizes the
rating categories used by IBCA for long-term debt ratings:
"AAA" - Obligations for which there is the lowest expectation of
investment risk. Capacity for timely repayment of principal and interest is
substantial such that adverse changes in business, economic or financial
conditions are unlikely to increase investment risk substantially.
"AA" - Obligations for which there is a very low expectation of
investment risk. Capacity for timely repayment of principal and interest is
substantial. Adverse changes in business, economic or financial conditions may
increase investment risk albeit not very significantly.
"A" - Obligations for which there is a low expectation of
investment risk. Capacity for timely repayment of principal and interest is
strong, although adverse changes in business,
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economic or financial conditions may lead to increased investment risk.
"BBB" - Obligations for which there is currently a low expectation
of investment risk. Capacity for timely repayment of principal and interest is
adequate, although adverse changes in business, economic or financial conditions
are more likely to lead to increased investment risk than for obligations in
higher categories.
"BB," "B," "CCC," "CC," and "C" - Obligations are assigned one of
these ratings where it is considered that speculative characteristics are
present. "BB" represents the lowest degree of speculation and indicates a
possibility of investment risk developing. "C" represents the highest degree
of speculation and indicates that the obligations are currently in default.
IBCA may append a rating of plus (+) or minus (-) to a rating to
denote relative status within major rating categories.
Thomson BankWatch 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 Thomson BankWatch for long-term debt
ratings:
"AAA" - This designation represents the highest category assigned
by Thomson BankWatch to long-term debt and indicates that the ability to repay
principal and interest on a timely basis is very high.
"AA" - This designation indicates a superior ability to repay
principal and interest on a timely basis with limited incremental risk versus
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 Thomson BankWatch's lowest
investment grade category and indicates an acceptable capacity to repay
principal and interest. Issues rated "BBB" are, however, 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
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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.
"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 Standard and Poor'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 Standard & Poor's Corporation for municipal
notes:
"SP-1" - The issuers of these municipal notes exhibit very strong
or strong capacity to pay principal and interest. Those issues determined to
possess overwhelming safety characteristics are given a plus (+) designation.
"SP-2" - The issuers of these municipal notes exhibit satisfactory
capacity to pay principal and interest.
"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 Investors Service, Inc.
for short-term notes:
"MIG-1"/"VMIG-1" - Loans bearing this designation 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" - Loans bearing this designation are of high
quality, with margins of protection ample although not so large as in the
preceding group.
"MIG-3"/"VMIG-3" - Loans bearing this designation are of favorable
quality, with all security elements accounted for but lacking the undeniable
strength of the preceding grades.
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Liquidity and cash flow protection may be narrow and market access for
refinancing is likely to be less well established.
"MIG-4"/"VMIG-4" - Loans bearing this designation are of adequate
quality, carrying specific risk but having protection commonly regarded as
required of an investment security and not distinctly or predominantly
speculative.
"SG" - Loans bearing this designation are of speculative quality
and lack margins of protection.
Fitch and Duff & Phelps 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 Portfolio may enter into futures
contracts and options for hedging purposes. 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, the Portfolio may use interest rate
futures as a defense, or hedge, against anticipated interest rate changes and
not for speculation. 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.
The 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 the Portfolio, through
using futures contracts.
Description of Interest Rate Futures Contracts. An interest rate
futures contract sale would create an obligation by the 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 the 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.
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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 in the sale exceeds the price in the offsetting purchase, the
Portfolio is 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's 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 and the Chicago Mercantile Exchange. The 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. The Portfolio may trade in any futures contract
for which there exists a public market, including, without limitation, the
foregoing instruments.
Examples of Futures Contract Sale. The Portfolio would engage in
an interest rate futures contract sale to maintain the income advantage from
continued holding of a long-term bond while endeavoring to avoid part or all of
the loss in market value that would otherwise accompany a decline in long-term
securities prices. Assume that the market value of a certain security in the
Portfolio tends to move in concert with the futures market prices of long-term
United States Treasury bonds ("Treasury bonds"). The advisor wishes to fix the
current market value of this portfolio security until some point in the future.
Assume the portfolio security has a market value of 100, and the investment
adviser believes that, because of an anticipated rise in interest rates, the
value will decline to 95. The Portfolio might enter into futures contract
sales of Treasury bonds for an equivalent of 98. If the market value of the
portfolio security
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does indeed decline from 100 to 95, the equivalent futures market price for the
Treasury bonds might also decline from 98 to 93.
In that case, the five-point loss in the market value of the
portfolio security would be offset by the five-point gain realized by closing
out the futures contract sale. Of course, the futures market price of Treasury
bonds might well decline to more than 93 or to less than 93 because of the
imperfect correlation between cash and futures prices mentioned below.
The investment adviser could be wrong in its forecast of interest
rates and the equivalent futures market price could rise above 98. In this
case, the market value of the portfolio securities, including the portfolio
security being protected, would increase. The benefit of this increase would
be reduced by the loss realized on closing out the futures contract sale.
If interest rate levels did not change, the Portfolio in the above
example might incur a loss of 2 points (which might be reduced by an
off-setting transaction prior to the settlement date). In each transaction,
transaction expenses would also be incurred.
Examples of Futures Contract Purchase. The Portfolio would engage
in an interest rate futures contract purchase when it is not fully invested in
long-term bonds but wishes to defer for a time the purchase of long-term bonds
in light of the availability of advantageous interim investments, e.g.,
shorter-term securities whose yields are greater than those available on
long-term bonds. The Portfolio's basic motivation would be to maintain for a
time the income advantage from investing in the short-term securities; the
Portfolio would be endeavoring at the same time to eliminate the effect of all
or part of an expected increase in market price of the long-term bonds that the
Portfolio may purchase.
For example, assume that the market price of a long-term bond that
the Portfolio may purchase, currently yielding 10%, tends to move in concert
with futures market prices of Treasury bonds. The investment adviser wishes to
fix the current market price (and thus 10% yield) of the long-term bond until
the time (four months away in this example) when it may purchase the bond.
Assume the long-term bond has a market price of 100, and the investment adviser
believes that, because of an anticipated fall in interest rates, the price will
have risen to 105 (and the yield will have dropped to about 9 1/2%) in four
months. The Portfolio might enter into futures contracts purchases of Treasury
bonds for an equivalent price of 98. At the same time, the Portfolio would
assign a pool of investments in short-term securities that are either maturing
in four months or earmarked for sale in four months, for purchase of the
long-term bond at an
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assumed market price of 100. Assume these short-term securities are yielding
15%. If the market price of the long-term bond does indeed rise from 100 to
105, the equivalent futures market price for Treasury bonds might also rise
from 98 to 103. In that case, the 5-point increase in the price that the
Portfolio pays for the long-term bond would be offset by the 5-point gain
realized by closing out the futures contract purchase.
The investment adviser could be wrong in its forecast of interest
rates; long-term interest rates might rise to above 10%; and the equivalent
futures market price could fall below 98. If short-term rates at the same time
fall to 10% or below, it is possible that the Portfolio would continue with its
purchase program for long-term bonds. The market price of available long-term
bonds would have decreased. The benefit of this price decrease, and thus yield
increase, will be reduced by the loss realized on closing out the futures
contract purchase.
If, however, short-term rates remained above available long-term
rates, it is possible that the Portfolio would discontinue its purchase program
for long-term bonds. The yield on short-term securities in the portfolio,
including those originally in the pool assigned to the particular long-term
bond, would remain higher than yields on long-term bonds. The benefit of this
continued incremental income will be reduced by the loss realized on closing
out the futures contract purchase. In each transaction, expenses would also be
incurred.
II. MARGIN PAYMENTS
Unlike when a Portfolio purchases or sells a security, no price is
paid or received by the 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 Portfolio's custodian an amount of cash or
cash equivalents, the value of which may vary but is generally equal to 10% or
less of the value of the contract. This amount is known as initial margin.
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 Portfolio
has purchased a futures contract and the price of the contract has risen in
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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 a 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 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.
III. RISKS OF TRANSACTIONS IN FUTURES CONTRACTS.
There are several risks in connection with the use of futures in
the Portfolio as a hedging device. One risk arises because of the imperfect
correlation between movements in the price of the future and movements in the
price of the securities which are the subject of the hedge. The price of the
future may move more than or less than the price of the securities being
hedged. If the price of the future moves less than the price of the securities
which are the subject of the hedge, the hedge will not be fully effective but,
if the price of the securities 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 securities being hedged has moved in a
favorable direction, this advantage will be partially offset by the loss on the
future. If the price of the future moves more than the price of the hedged
securities, the Portfolio will experience either a loss or gain on the future
which will not be completely offset by movements in the price of the securities
which are the subject of the hedge. To compensate for the imperfect
correlation of movements in the price of securities 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 securities being
hedged if the volatility over a particular time period of the prices of such
securities has been greater than the volatility over such time period of the
future, or if otherwise deemed to be appropriate by the investment adviser.
Conversely, a Portfolio may buy or sell fewer futures contracts if the
volatility over a particular time period of the prices of the securities 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
adviser. It is also possible that, where the Portfolio has sold futures to
hedge its portfolio against a decline in the market, the market
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may advance and the value of securities held in the Portfolio may decline. If
this occurred, the Portfolio would lose money on the future and also experience
a decline in value in its portfolio securities.
Where 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 securities (or options) in an orderly fashion, it is
possible that the market may decline instead; if the Portfolio then concludes
not to invest in securities or options 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
securities purchased.
In instances involving the purchase of futures contracts by a
Portfolio, an amount of cash and cash equivalents, equal to the market value of
the futures contracts, will be deposited in a segregated account with the
Portfolio's custodian and/or in a margin account with a broker to collateralize
the position and thereby insure that the use of such futures is unleveraged.
In addition to the possibility that there may be an imperfect
correlation, or no correlation at all, between movements in the futures and the
securities being hedged, the price of futures may not correlate perfectly with
movement in the cash market due to certain market distortions. 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 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
Portfolio intend to purchase or sell
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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 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.
Successful use of futures by a Portfolio is also subject to the
investment adviser's ability to predict correctly movements in the direction of
the market. For example, if a 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 of 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.
IV. OPTIONS ON FUTURES CONTRACTS.
The Portfolio may purchase 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,
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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.
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). In
addition, the purchase of an option also entails the risk that changes in the
value of the underlying futures contract will not be fully reflected 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).
V. ACCOUNTING AND TAX TREATMENT.
Accounting for futures contracts and related options will be in
accordance with generally accepted accounting principles.
Generally, futures contracts and options on futures contracts held
by the Portfolio at the close of the Portfolio's taxable year will be treated
for federal income tax purposes as sold for their fair market value on the last
business day of such year, a process known as "mark-to-market." Forty percent
of any gain or loss resulting from such constructive sale will be treated as
short-term capital gain or loss, and 60% of such gain or loss will be treated
as long-term capital gain or loss without regard to the length of time the
Portfolio holds the futures contract or option ("the 40%-60% rule"). The
amount of any capital gain or loss actually realized by a Portfolio in a
subsequent sale or other disposition of those futures contracts or options will
be adjusted to reflect any capital gain or loss taken into account by the
Portfolio in a prior year as a result of the constructive sale of the contracts
or options. With respect to futures contracts to sell, which are regarded as
parts of a "mixed straddle" because their values fluctuate inversely to the
values of specific securities held by the Portfolio, losses as to such
contracts to sell may be subject to certain loss deferral rules which limit the
amount of loss currently deductible on either part of the straddle to the
amount thereof
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which exceeds the unrecognized gain (if any) with respect to the other part of
the straddle, and to certain wash sales regulations. Under short sales rules,
which will also be applicable, the holding period of the securities forming
part of the straddle will (if they have not been held for the long-term holding
period) be deemed not to begin prior to termination of the straddle. With
respect to certain futures contracts and related options, deductions for
interest and carrying charges will not be allowed. Notwithstanding the rules
described above, with respect to futures contracts to sell which are properly
identified as such, the Portfolio may make an election which will exempt (in
whole or in part) those identified futures contracts from being treated for
federal income tax purposes as sold on the last business day of the Portfolio's
taxable year, but gains and losses will be subject to such short sales, wash
sales and loss deferral rules and the requirement to capitalize interest and
carrying charges. Under Temporary Regulations, the Portfolio would be allowed
(in lieu of the foregoing) to elect either (1) to offset gains or losses from
portions which are part of a mixed straddle by separately identifying each
mixed straddle to which such treatment applies, or (2) to establish a mixed
straddle account for which gains and losses would be recognized and offset on a
periodic basis during the taxable year. Under either election, the 40%-60%
rule will apply to the net gain or loss attributable to the futures contracts,
but in the case of a mixed straddle account election, not more than 50 percent
of any net gain may be treated as long-term and no more than 40 percent of any
net loss may be treated as short-term.
Qualification as a regulated investment company under the Code
requires that the Fund satisfy certain requirements with respect to the source
of its income during a taxable year. At least 90% of the gross income of the
Fund must be derived from dividends, interests, payments with respect to
securities loans, gains from the sale or other disposition of stock, securities
or foreign currencies, and other income (including, but not limited to, gains
from options, futures, or forward contracts) derived with respect to the Fund's
business of investing in such stock, securities or currencies. The Treasury
Department may by regulation exclude from qualifying income foreign currency
gains that are not directly related to the Fund's principal business of
investing in stock or securities, or options and futures with respect to stock
or securities. Any income derived by the Portfolio from a partnership or trust
is treated for this purpose as derived with respect to the Portfolio's business
of investing in stock, securities or currencies only to the extent that such
income is attributable to items of income which would have been qualifying
income if realized by the Portfolio in the same manner as by the partnership or
trust.
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An additional requirement for qualification by the Fund as a
regulated investment company under the Code is the Short-Short test described
earlier in this Statement of Additional Information. With respect to futures
contracts and other financial instruments subject to the mark-to-market rules,
the Internal Revenue Service has ruled in private letter rulings that a gain
realized from such a futures contract or financial instrument will be treated
as being derived from a security held for three months or more (regardless of
the actual period for which the contract or instrument is held) if the gain
arises as a result of a constructive sale under the mark-to-market rules, and
will be treated as being derived from a security held for less than three
months only if the contract or instrument is terminated (or transferred) during
the taxable year (other than by reason of marking- to-market) and less than
three months have elapsed between the date the contract or instrument is
acquired and the termination date. In determining whether the Fund meets the
30% test for a taxable year, increases and decreases in the value of the
Portfolio's futures contracts and other investments that qualify as part of a
"designated hedge," as defined in the Code, may be netted.
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PACIFIC HORIZON FUNDS, INC.
(THE "COMPANY")
PART B
STATEMENT OF ADDITIONAL INFORMATION
FOR THE
NATIONAL MUNICIPAL BOND FUND
JULY 1, 1995
(AS REVISED MARCH 8, 1996)
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
The Company . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Investment Objectives and Policies . . . . . . . . . . . . . . 2
Additional Purchase and Redemption Information . . . . . . . . 14
Additional Information Concerning Taxes . . . . . . . . . . . . 21
Management . . . . . . . . . . . . . . . . . . . . . . . . . . 24
General Information . . . . . . . . . . . . . . . . . . . . . . 46
Appendix A . . . . . . . . . . . . . . . . . . . . . . . . . . A-1
Appendix B . . . . . . . . . . . . . . . . . . . . . . . . . . B-1
</TABLE>
This Statement of Additional Information applies to the Pacific Horizon
National Municipal Bond Fund (the "Fund") of the Company. This Statement of
Additional Information is meant to be read in conjunction with the Prospectus
dated July 1, 1995, as may from time to time be revised (the "Prospectus"),
which describes the Fund. This Statement of Additional Information is
incorporated by reference in its entirety into the Prospectus. Because this
Statement of Additional Information is not itself a prospectus, no investment in
shares of the Fund should be made solely upon the information contained herein.
Copies of the Prospectus may be obtained by calling Concord Financial Group,
Inc. at 800-332-3863. Capitalized terms used but not defined herein have the
same meaning as in the Prospectus.
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THE COMPANY
The Company was organized on October 27, 1982 as a Maryland
corporation.
The Fund commenced operations on January 28, 1994. The Fund seeks to
achieve its investment objective by investing substantially all of its assets in
a diversified investment portfolio of an open-end management investment company
(the "Portfolio") having the same investment objective as that of the Fund.
The Company also offers other investment portfolios which are described
in separate Prospectuses and Statements of Additional Information. For
information concerning these other portfolios contact the Distributor at the
telephone number stated on the cover page of this Statement of Additional
Information.
INVESTMENT OBJECTIVES AND POLICIES
The Prospectus for the Fund describes the investment objective of the
Fund and the Portfolio. Since the investment characteristics of the Fund will
correspond to those of the Portfolio, the following is a discussion of the
various investments of and techniques employed by the Portfolio. The following
information supplements and should be read in conjunction with the description
of the investment objective and policies for the Portfolio in the Prospectus for
the Fund.
PORTFOLIO TRANSACTIONS
The portfolio turnover rate is calculated by dividing the lesser of
purchases or sales of portfolio securities for the year by the monthly average
value of the portfolio securities. The calculation excludes all securities whose
maturities at the time of acquisition were one year or less. Portfolio turnover
may vary greatly from year to year as well as within a particular year, and may
also be affected by cash requirements for redemptions of shares and by
requirements which enable the Company to receive certain favorable tax
treatment. Portfolio turnover will not be a limiting factor in making portfolio
decisions. For the fiscal year ended February 28, 1995, and for the period from
January 28, 1994 (commencement of operations) through February 28, 1994, the
portfolio turnover rate for the Portfolio was 6.19% and 0%, respectively.
Subject to the general control of the Portfolio's Board of Trustees,
Bank of America National Trust and Savings Association ("Bank of America" or the
"investment adviser") is responsible for, makes decisions with respect to, and
places orders for, all purchases and sales of portfolio securities for the
Portfolio. Securities purchased and sold by the Portfolio
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are generally principal transactions without brokerage commissions. The cost
of securities purchased by the Portfolio from underwriters generally 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.
For the fiscal year ended February 28, 1995, and for the period from January
28, 1994 (commencement of operations) through February 28, 1994, the Portfolio
paid no brokerage commissions.
In executing portfolio transactions and selecting brokers or dealers,
it is the Portfolio's policy to seek the best overall terms available. The
Investment Advisory Agreement between the Portfolio and Bank of America provides
that, in assessing the best overall terms available for any transaction, Bank of
America shall consider factors it deems 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, for the specific transaction and on a continuing basis. In
addition, the Investment Advisory Agreement authorizes Bank of America, subject
to the approval of the Board of Trustees of the Portfolio, to cause the
Portfolio to pay a broker-dealer which furnishes brokerage and research services
a higher commission than that which might be charged by another broker-dealer
for effecting the same transaction, provided that such commission is deemed
reasonable in terms of either that particular transaction or the overall
responsibilities of Bank of America to the Fund, Company or Portfolio. Brokerage
and research services may include: (1) advice as to the value of securities, the
advisability of investing in, purchasing or selling securities and the
availability of securities or purchasers or sellers of securities; and (2)
analyses and reports concerning industries, securities, economic factors and
trends, portfolio strategy and the performance of accounts.
It is possible that certain of the brokerage and research services
received will primarily benefit one or more other investment companies or other
accounts for which investment discretion is exercised. Conversely, the Portfolio
may be the primary beneficiary of the brokerage or research services received as
a result of portfolio transactions effected for such other accounts or
investment companies.
Brokerage and research services so received are in addition to and not
in lieu of services required to be performed by Bank of America and do not
reduce the advisory fee payable to Bank of America. Such services may be useful
to Bank of America in serving both the Company, the Portfolio and other clients
and, conversely, services obtained by the placement of business of other clients
may be useful to Bank of America in carrying out its obligations to the Company
and the Portfolio. In connection with its investment management services with
respect to the
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Portfolio, Bank of America will not acquire certificates of deposit or other
securities issued by itself or its affiliates, and will give no preference to
certificates of deposit or other securities issued by Service Organizations.
In addition, portfolio securities in general will be purchased from and sold to
affiliates of the Company, the Portfolio, Bank of America, the Distributor and
their affiliates acting as principal, underwriter, syndicate member,
market-maker, dealer, broker or in any similar capacity, provided such
purchase, sale or dealing is permitted under the Investment Company Act of 1940
(the "1940 Act") and the rules thereunder.
The Portfolio may participate, if and when practicable, in bidding for
the purchase of securities of the U.S. Government and its agencies and
instrumentalities directly from an issuer in order to take advantage of the
lower purchase price available to members of a bidding group. The Portfolio will
engage in this practice only when Bank of America, in its sole discretion,
subject to guidelines adopted by the Board of Trustees of the Portfolio,
believes such practice to be in the interest of the Portfolio.
To the extent permitted by law, Bank of America may aggregate the
securities to be sold or purchased on behalf of the Portfolio with those to be
sold or purchased for other investment companies or common trust funds in order
to obtain best execution.
The Company is required to identify any securities of its regular
brokers or dealers (as defined in Rule 10b-1 under the 1940 Act or their parents
held by the Company as of the close of its most recent fiscal year. As of
February 28, 1995: (a) the Treasury Fund held the following securities,
Repurchase Agreement with Goldman, Sachs & Co. in the principal amount of
$95,000,000; Repurchase Agreement with Merrill Lynch Government Securities, Inc.
in the principal amount of $95,000,000; (b) the Prime Fund held the following
securities, Merrill Lynch & Co., Inc., commercial paper in the principal amount
of $l00,000,000; Goldman, Sachs Group L.P., Daily Variable Rate Master Note in
the principal amount of $120,000,000; Morgan Stanley Group, Inc., Daily Variable
Rate Master Note in the principal amount of $120,000,000; Bear Stearns Co.,
Inc., Series B, Monthly Variable Rate Note in the principal amount of
$100,000,000; Repurchase Agreement with Goldman, Sachs & Co. in the principal
amount of $120,000,000; (c) the Government Fund held the following securities,
Repurchase Agreement with Goldman, Sachs & Co. in the principal amount of
$40,000,000; Repurchase Agreement with Merrill Lynch Government Securities, Inc.
in the principal amount of $40,000,000; and (d) the Prime Value Fund held the
following securities, Merrill Lynch & Co., Inc., commercial paper in the
principal amount of $7,000,000; Goldman, Sachs Group L.P., Daily Variable Rate
Master Note in the principal amount of $7,000,000;
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Repurchase Agreement with Dean Witter Reynolds, Inc. in the principal amount of
$8,000,000; Repurchase Agreement with Goldman, Sachs & Co. in the principal
amount of $8,000,000.
Merrill Lynch & Co., Inc., Goldman Sachs & Co., Bear Stearns Co., Inc.,
Morgan Stanley & Co. Incorporated, Shearson Lehman Brothers, Inc., Dean Witter
Reynolds, Inc. and Paine Webber are considered to be regular brokers and dealers
of the Company.
TYPES OF OBLIGATIONS, INVESTMENT RISKS, AND OTHER INVESTMENT INFORMATION
Municipal Securities. The Portfolio currently intends that under
ordinary market conditions 80% of its total assets will be invested in municipal
securities. This is not, however, a fundamental investment policy.
Municipal Securities are debt obligations issued to obtain funds for
various public purposes, including the construction of a wide range of public
facilities, the refunding of outstanding obligations, the payment of general
operating expenses and the extension of loans to public institutions and
facilities. In addition, certain types of private activity bonds (including
industrial development bonds under prior law) are issued by or on behalf of
public authorities to finance various privately-operated facilities. Such
obligations are included within the term Municipal Securities if the interest
paid thereon is exempt from regular Federal income tax.
The Portfolio may purchase short-term Tax Anticipation Notes, Bond
Anticipation Notes, Revenue Anticipation Notes and other forms of short-term
tax-exempt loans. Such notes are issued with a short-term maturity in
anticipation of the receipt of tax funds, the proceeds of bond placements or
other revenues. The Portfolio may also purchase tax-exempt commercial paper.
There are, of course, variations in the quality of Municipal
Securities, both within a particular classification and between classifications,
and the yields on Municipal Securities depend upon a variety of factors,
including general money market conditions, the financial condition of the
issuer, general conditions of the municipal bond market, the size of a
particular offering, the maturity of the obligation and the rating of the issue.
The ratings of Moody's Investors Service, Inc. ("Moody's"), Standard & Poor's
Ratings Group, Division of McGraw Hill ("S&P"), Fitch Investor's Service, Inc.
("Fitch") and Duff & Phelps Credit Rating Co. ( "D&P") represent their opinions
as to the quality of Municipal Securities. It should be emphasized, however,
that ratings are general and are not absolute standards of quality, and
Municipal Securities with the same maturity, interest rate and rating may have
different yields while
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Municipal Securities of the same maturity and interest rate with different
ratings may have the same yield. Subsequent to its purchase by the Portfolio,
an issue of Municipal Securities may cease to be rated or its rating may be
reduced. The Portfolio's investment adviser will consider such an event in
determining whether the Portfolio should continue to hold the obligation.
An issuer's obligations under its Municipal Securities are subject to
the provisions of bankruptcy, insolvency and other laws affecting the rights and
remedies of creditors, such as the federal Bankruptcy Code, and laws, if any,
which may be enacted by federal or state legislatures extending the time for
payment of principal or interest, or both, or imposing other constraints upon
enforcement of such obligations. The power or ability of an issuer to meet its
obligations for the payment of interest on, and principal of, its Municipal
Securities may be materially adversely affected by litigation or other
conditions. Further, it should also be noted with respect to all Municipal
Securities issued after August 15, 1986 (August 31, 1986 in the case of certain
bonds), the issuer must comply with certain rules formerly applicable only to
"industrial development bonds" which, if the issuer fails to observe them, could
cause interest on the Municipal Securities to become taxable retroactive to the
date of issue.
Information about the financial condition of issuers of Municipal
Securities may be less available than about corporations a class of whose
securities is registered under the Securities Exchange Act of 1934.
From time to time, proposals have been introduced before Congress for
the purpose of restricting or eliminating the federal income tax exemption for
interest on Municipal Securities. For example, pursuant to federal tax
legislation passed in 1986, interest on certain private activity bonds must be
included in an investor's federal alternative minimum taxable income, and
corporate investors must include all tax-exempt interest in their federal
alternative minimum taxable income. (See the Fund's Prospectus under "Tax
Information.") Proposals to further restrict or eliminate the tax benefits of
municipal securities, while pending or if enacted, might materially adversely
affect the availability of Municipal Securities for investment by the Portfolio
and the liquidity and value of the Portfolio. In such an event, the Portfolio
and the Fund would re-evaluate its investment objective and policies and
consider changes in its structure or possible dissolution.
SHORT-TERM INVESTMENTS
As stated in the Fund's Prospectus, Bank of America may make short-term
investments pending investment, during temporary
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defensive periods, or if, in the opinion of Bank of America, suitable
tax-exempt obligations are unavailable. The income earned from such
investments may be taxable and therefore not included in the "exempt-interest"
dividends the Fund may pay. The following discussion supplements the
description of such investments in the Prospectus.
Bank Certificates of Deposit and Bankers' Acceptances. Certificates of
deposit and bankers' acceptances are eligible investments for the Portfolio, as
described in the Fund's Prospectus. 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. Certificates of deposit and bankers acceptances
will be dollar-denominated obligations of domestic or foreign banks or
financial institutions with total assets at the time of purchase in excess of
$2.5 billion.
Commercial Paper and Short-Term Notes. The Portfolio may invest a
portion of its assets in commercial paper and short-term notes. Commercial paper
consists of unsecured promissory notes issued by corporations. Except as noted
below with respect to variable and floating rate instruments, issues of
commercial paper and short-term notes will normally have maturities of less than
9 months and fixed rates of return, although such instruments may have
maturities of up to one year. Commercial paper and short-term notes will consist
of issues rated at the time of purchase A-2 or higher by S&P, Prime-2 or higher
by Moody's, or similarly rated by another nationally recognized statistical
rating organization ("NRSRO"); or if unrated, will be determined by Bank of
America to be of comparable quality under procedures established by the Board of
Trustees of the Portfolio. These rating symbols are described in Appendix A.
Repurchase Agreements. The Portfolio is permitted to enter into
repurchase agreements with respect to its portfolio securities. Pursuant to such
agreements, the Portfolio acquires securities from financial institutions such
as banks and broker-dealers as are deemed to be creditworthy subject to the
seller's agreement to repurchase and the agreement of the Portfolio to resell
such securities at a mutually agreed upon date and price. Repurchase agreements
maturing in more than seven days will not exceed 15% of the value of the total
assets of the Portfolio. The Portfolio is not permitted to enter into repurchase
agreements with Bank of America or its affiliates, and will give no preference
to repurchase agreements with Service Organizations. The repurchase price
generally equals the price paid by the Portfolio plus interest negotiated on the
basis of
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current short-term rates (which may be more or less than the rate on the
underlying portfolio security). Securities subject to repurchase agreements
will be held by the custodian or sub-custodian of the Portfolio or in the
Federal Reserve/Treasury Book-Entry System. The seller under a repurchase
agreement will be required to deliver instruments the value of which is 102% of
the repurchase price (excluding accrued interest), provided that
notwithstanding such requirement, the adviser shall require that the value of
the collateral, after transaction costs (including loss of interest) reasonably
expected to be incurred on a default, shall be equal to or greater than the
resale price (including interest) provided in the agreement. If the seller
defaulted on its repurchase obligation, the Portfolio would suffer a loss
because of adverse market action or to the extent that the proceeds from a sale
of the underlying securities were less than the repurchase price under the
agreement. Bankruptcy or insolvency of such a defaulting seller may cause the
Portfolio's rights with respect to such securities to be delayed or limited.
Income from repurchase agreements is taxable and therefore not included in the
"exempt-interest" dividends which the Fund will pay. Repurchase agreements are
considered to be loans by the Portfolio under the 1940 Act.
U.S. Government Obligations. The Portfolio is permitted to make
investments in U.S. Government obligations. Such obligations include Treasury
bills, certificates of indebtedness, notes and bonds, and issues of such
entities as the Government National Mortgage Association, Export-Import Bank of
the United States, Tennessee Valley Authority, Resolution Funding Corporation,
Farmers Home Administration, Federal Home Loan Banks, Federal Intermediate
Credit Banks, Federal Farm Credit Banks, Federal Land Banks, Federal Housing
Administration, Federal National Mortgage Association, Federal Home Loan
Mortgage Corporation, and the Student Loan Marketing Association. Treasury bills
have maturities of one year or less, Treasury notes have maturities of one to
ten years and Treasury bonds generally have maturities of more than ten years.
Some of these obligations, such as those of the Government National Mortgage
Association, are supported by the full faith and credit of the U.S. Treasury;
others, such as those of the Export-Import Bank of the United States, are
supported by the right of the issuer to borrow from the Treasury; others, such
as those of the Federal National Mortgage Association, are supported by the
discretionary authority of the U.S. Government to purchase the agency's
obligations; still others, such as those of the Student Loan Marketing
Association, are supported only by the credit of the instrumentality. No
assurance can be given that the U.S. Government would provide financial support
to U.S. Government sponsored instrumentalities if it is not obligated to do so
by law.
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Reverse Repurchase Agreements. As described in the Prospectus, the
Portfolio is permitted to borrow funds for temporary purposes by entering into
reverse repurchase agreements with such financial institutions as banks and
broker-dealers in accordance with the investment limitations described therein.
Whenever the Portfolio enters into a reverse repurchase agreement, it will place
in a segregated account maintained with its custodian liquid assets such as
cash, U.S. Government securities or other liquid high grade debt securities
having a value equal to the repurchase price (including accrued interest) and
Bank of America will subsequently continuously monitor the account for
maintenance of such equivalent value. The Portfolio intends to enter into
reverse repurchase agreements to avoid otherwise having to sell securities
during unfavorable market conditions in order to meet redemptions. Reverse
repurchase agreements are considered to be borrowings by the Portfolio under the
1940 Act.
OTHER INVESTMENTS
Variable and Floating Rate Instruments. The Portfolio may acquire
variable and floating rate instruments. Such instruments are frequently not
rated by credit rating agencies. However, in determining the creditworthiness of
unrated variable and floating rate instruments and their eligibility for
purchase by the Portfolio, Bank of America will consider the earning power, cash
flow and other liquidity ratios of the issuers of such instruments (which
include financial, merchandising, bank holding and other companies) and will
continuously monitor their financial condition. An active secondary market may
not exist with respect to particular variable or floating rate instruments
purchased by the Portfolio. The absence of such an active secondary market could
make it difficult to dispose of a variable or floating rate instrument in the
event the issuer of the instrument defaulted on its payment obligation or during
periods that the Portfolio is not entitled to exercise its demand rights, and
the Portfolio could, for these or other reasons, suffer a loss to the extent of
the default. Investments in illiquid variable and floating rate instruments
(instruments which are not payable upon seven days' notice and do not have
active trading markets) are subject to the Portfolio's 15% limitation on
illiquid securities. Variable and floating rate instruments may be secured by
bank letters of credit.
Zero Coupon Securities. The Portfolio may invest in zero coupon
securities which pay no cash income and are sold at substantial discounts from
their value at maturity. When held to maturity, their entire income, which
consists of accretion of discount, comes from the difference between the
purchase price and their value at maturity.
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The discount varies, depending on the time remaining until maturity or
cash payment date, prevailing interests rates, liquidity of the security and the
perceived credit quality of the issuer. The discount, in the absence of
financial difficulties of the issuer, decreases as the final maturity or cash
payment date of the security approaches. The market prices of zero coupon and
delayed interest securities are generally more volatile and more likely to
respond to changes in interest rates than the market prices of securities having
similar maturities and credit quality that pay interest periodically. Current
federal income tax law requires that a holder of a zero coupon security report
as income each year the portion of the original issue discount on such security
(other than tax-exempt original issue discount from a zero coupon security) that
accrues that year, even though the holder receives no cash payments of interest
during the year. Zero coupon securities are subject to greater market value
fluctuations from changing interest rates than debt obligations of comparable
maturities which make current distributions of interest (cash).
When-Issued Securities, Forward Commitments and Delayed Settlements.
The Portfolio may purchase securities on a "when-issued," forward commitment or
delayed settlement basis. When the Portfolio agrees to purchase securities on a
when-issued, forward commitment or delayed settlement basis, its custodian will
set aside cash or liquid portfolio securities equal to the amount of the
commitment in a separate account. Normally, the custodian will set aside
portfolio securities to satisfy a purchase commitment. In such a case, the
Portfolio may be required subsequently to place additional assets in the
separate account in order to assure that the value of the account remains equal
to the amount of the commitment. It may be expected that the net assets of the
Portfolio will fluctuate to a greater degree when it sets aside portfolio
securities to cover such purchase commitments than when it sets aside cash. The
Portfolio does not intend to engage in these transactions for speculative
purposes but only in furtherance of its investment objective. Because the
Portfolio will set aside cash or liquid portfolio securities to satisfy its
purchase commitments in the manner described, its liquidity and the ability of
the investment adviser to manage it may be affected in the event the forward
commitments, commitments to purchase when-issued securities and delayed
settlements ever exceeded 25% of the value of the Portfolio's net assets.
The Portfolio will purchase securities on a when-issued, forward
commitment or delayed settlement basis only with the intention of completing the
transaction. If deemed advisable as a matter of investment strategy, however,
the Portfolio may dispose of or renegotiate a commitment after it is entered
into, and may sell securities it has committed to purchase before those
securities are delivered to the Portfolio on the settlement date.
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In these cases the Portfolio may realize a taxable capital gain or loss.
When the Portfolio engages in when-issued, forward commitment and
delayed settlement transactions, it relies on the other party to consummate the
trade. Failure of such party to do so may result in the Portfolio's incurring a
loss or missing an opportunity to obtain a price considered to be advantageous.
Stand-By Commitments. The Portfolio may acquire "stand-by commitments"
with respect to Municipal Securities held in its portfolio. Under a "stand-by
commitment," a dealer agrees to purchase from the Portfolio, at the Portfolio's
option, specified Municipal Securities at a specified price. "Stand-by
commitments" acquired by the Portfolio may also be referred to in this Statement
of Additional Information as "put" options.
The amount payable to the Portfolio upon its exercise of a "stand-by
commitment" is normally (i) the Portfolio's acquisition cost of the Municipal
Securities (excluding any accrued interest which the Portfolio paid on their
acquisition), less any amortized market premium or plus any amortized market or
original issue discount during the period the Portfolio owned the securities,
plus (ii) all interest accrued on the securities since the last interest payment
date during that period. A "stand-by commitment" may be sold, transferred or
assigned by the Portfolio only with the instrument involved.
The Portfolio expects that "stand-by commitments" will generally be
available without the payment of any direct or indirect consideration. However,
if necessary or advisable, the Portfolio may pay for a "stand-by commitment"
either separately in cash or by paying a higher price for portfolio securities
which are acquired subject to the commitment (thus reducing the yield to
maturity otherwise available for the same securities). The total amount paid in
either manner for outstanding "stand-by commitments" held by the Portfolio will
not exceed 1/2 of 1% of the value of its total assets calculated immediately
after each "stand-by commitment" is acquired.
The Portfolio intends to obtain "stand-by commitments" only from
dealers, banks and broker-dealers which, in the investment adviser's opinion,
present minimal credit risks. The Portfolio's reliance upon the credit of these
dealers, banks and broker-dealers is secured by the value of the underlying
Municipal Securities that are subject to a commitment.
The Portfolio would acquire "stand-by commitments" solely to facilitate
portfolio liquidity and does not intend to exercise its rights thereunder for
trading purposes. The acquisition of a "stand-by commitment" would not affect
the valuation or assumed maturity of the underlying Municipal
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Securities, which would continue to be valued in accordance with the ordinary
method of valuation employed by the Portfolio. "Stand-by commitments" which
would be acquired by the Fund would be valued at zero in determining net asset
value. Where the Portfolio paid any consideration directly or indirectly for a
"stand-by commitment," its cost would be reflected as unrealized depreciation
for the period during which the commitment was held by the Portfolio.
OTHER INVESTMENT LIMITATIONS
The Prospectus for the Fund sets forth or summarizes certain
fundamental policies that may not be changed with respect to the Fund or the
Portfolio without the affirmative vote of the holders of the majority of the
Fund's outstanding shares or the Portfolio's outstanding interests (as defined
below under "General Information - Shareholder Vote"). The following is a list
of additional fundamental policies which may not be changed with respect to the
Fund or the Portfolio without such a vote.
NEITHER THE FUND NOR THE PORTFOLIO MAY:
1. Invest 25% or more of its total assets in the securities of one or
more issuers conducting their principal business activities in the same
industry, except that this limitation shall not apply to Municipal Securities or
governmental guarantees of Municipal Securities, and that all of the assets of
the Fund may be invested in the Portfolio or another investment company.
2. Purchase or sell real estate (however, the Portfolio may, to the
extent appropriate to its investment objective, purchase securities issued by
the U.S. Government, its agencies and instrumentalities, purchase Municipal
Securities secured by real estate or interests therein or securities issued by
companies investing in real estate or interests therein).
3. Sell securities short or purchase securities on margin, except
such short-term credits as are necessary for the clearance of transactions. For
this purpose, the deposit or payment by the Portfolio for initial or maintenance
margin in connection with futures contracts is not considered to be the purchase
or sale of a security on margin.
4. Underwrite the securities of other issuers, except that all of the
assets of the Fund may be invested in the Portfolio or another investment
company.
5. Purchase securities of companies for the purpose of exercising
control.
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6. Purchase or sell commodity contracts, or invest in oil, gas or
mineral exploration or development programs (however, the Portfolio may, to the
extent appropriate to its investment objective, purchase publicly traded
securities of companies engaging in whole or in part in such activities), but
may enter into futures contracts and options thereon in accordance with its
Prospectus.
7. Acquire any other investment company or investment company
security except as provided for in the Investment Company Act of 1940; provided
that all of the assets of the Fund may be invested in the Portfolio or another
investment company.
8. Write or sell puts, calls, straddles, spreads, or combinations
thereof except that the Portfolio may acquire standby commitments with respect
to its Municipal Securities and may enter into futures contracts and options
thereon to the extent disclosed in the Prospectus and this Statement of
Additional Information.
If a percentage restriction is satisfied at the time of investment, a
later increase or decrease in such percentage resulting from a change in asset
value will not constitute a violation of such restriction.
In order to permit the Fund to sell its shares in certain states, the
Company or the Portfolio may make commitments more restrictive than the
investment policies and limitations described above. As of the date of this
Statement of Additional Information, the following such commitments have been
made:
1. The Portfolio will not invest in oil, gas or mineral leases.
2. The Portfolio will not purchase or sell real property, including
limited partnership interests, but excluding readily marketable
interests in real estate investment trusts ("REITS") or readily
marketable securities of companies that invest in real estate
investments in real estate limited partnerships.
3. The Portfolio will not purchase or retain the securities of any
issuer if the Officers or Trustees of the Portfolio or its
investment adviser, owning beneficially more than one half of one
percent of the securities of an issuer together own beneficially
more than 5% of the securities of that issuer.
4. The Portfolio will not invest more than 5% of its total assets in
the securities of issuers which
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together with any predecessors have a record of less than three
years continuous operation.
If the Portfolio determines that a commitment that has been made is no
longer in its best interests, it will revoke the commitment and notify the Fund
that it has done so. In such an event, the Fund may no longer be able to sell
its shares in the state where such commitment has been revoked.
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION
Information on how to purchase and redeem Fund shares, and how such
shares are priced, is included in the Prospectus. The net asset value of the
Portfolio is determined at the same time and on the same days as the net asset
values per share of the Fund is determined. The net asset value of the Fund is
equal to the Fund's pro rata share of the total investments and other assets of
the Portfolio, less any liabilities with respect to the Fund, including the
Fund's pro rata share of the Portfolio's liabilities. Additional information is
contained below.
The Fund's assets are valued for purposes of pricing sales and
redemptions by an independent pricing service ("Service") approved by the
Portfolio's Board of Trustees. When, in the judgment of the Service, quoted bid
prices for portfolio securities are readily available and are representative of
the bid side of the market, these investments are valued at the mean between
quoted bid prices (as obtained by the Service from dealers in such securities)
and asked prices (as calculated by the Service based upon its evaluation of the
market for such securities). Other investments are carried at fair value as
determined by the Service, based on methods which include consideration of
yields or prices of municipal bonds of comparable quality, coupon, maturity and
type; indications as to values from dealers; and general market conditions. The
Service may also employ electronic data processing techniques and matrix systems
to determine value. Short-term debt securities with remaining maturities of 60
days or less are valued at amortized cost, which approximates market value. The
amortized cost method involves valuing a security at its cost on the date of
purchase or, in the case of securities purchased with more than 60 days
remaining to maturity and to be valued on the amortized cost basis only during
the final 60 days of its maturity, the market value on the 61st day prior to
maturity. Thereafter the Master Trust assumes a constant amortization to
maturity of the difference between the principal amount due at maturity and
cost.
SUPPLEMENTARY PURCHASE INFORMATION
For the purpose of applying the Right of Accumulation or Letter of
Intent privileges described in the Prospectus, the
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scale of sales loads applies to purchases made by any "purchaser," which term
includes an individual and/or spouse purchasing securities for his, her or
their own account or for the account of any minor children; or a trustee or
other fiduciary account (including a pension, profit-sharing or other employee
benefit trust created pursuant to a plan qualified under Section 401 of the
Internal Revenue Code) although more than one beneficiary is involved; or "a
qualified group" which has been in existence for more than six months and has
not been organized for the purpose of buying redeemable securities of a
registered investment company at a discount, provided that the purchases are
made through a central administrator or a single dealer, or by other means
which result in economy of sales effort or expense. A "qualified group" must
have more than 10 members, must be available to arrange for group meetings
between representatives of the Fund and the members, and must be able to
arrange for mailings to members at reduced or no cost to the Distributor. The
value of shares eligible for the Right of Accumulation privilege may also be
used as a credit toward completion of the Letter of Intent privilege. Such
shares will be valued at their offering price prevailing on the date of
submission of the Letter of Intent. Distributions on shares held in escrow
pursuant to the Letter of Intent privilege will be credited to the shareholder,
but such shares are not eligible for the Fund's Exchange Privilege.
The computation of the hypothetical offering price per share for the
Fund based on the value of the Fund's net assets on February 28, 1995 and the
Fund's outstanding securities on such date is as follows:
NATIONAL MUNICIPAL BOND FUND
<TABLE>
<S> <C>
Net Assets $2,519,992
Outstanding Securities 261,439
Net Asset Value Per Share $ 9.64
Sales Charge - 4.50% of
offering price (4.71% of
net asset value per share) $ 0.45
Offering Price to Public $ 10.09
</TABLE>
SUPPLEMENTARY REDEMPTION INFORMATION
Shares of the Fund for which orders for wire redemption are received on
a business day before the close of regular trading hours on the New York Stock
Exchange (currently 4:00 p.m. (Eastern time) will be redeemed as of the close of
regular
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<PAGE> 324
trading hours on such Exchange and the proceeds of redemption (less any
applicable contingent deferred sales charge imposed on shareholders who
purchased shares of the Fund of $1 million or more without a front-end sales
load and redeem such shares within 2 years after purchase) will normally be
wired in federal funds on the next business day to the commercial bank
specified by the investor on the Account Application (or other bank of record
on the investor's file with the Transfer Agent). To qualify to use the wire
redemption privilege, the payment for Fund shares must be drawn on, and
redemption proceeds paid to, the same bank and account as designated on the
Account Application (or other bank of record as described above). If the
proceeds of a particular redemption are to be wired to another bank, the request
must be in writing and signature guaranteed. Shares for which orders for wire
redemption are received after the close of regular trading hours on the New York
Stock Exchange or on a non-business day will be redeemed as of the close of
trading on such Exchange on the next day on which shares of the Fund are priced
and the proceeds (less any applicable contingent deferred sales charge imposed
on shareholders who purchased shares of the Fund of $1 million or more without a
front-end sales load and redeem such shares within 2 years after purchase) will
normally be wired in federal funds on the next business day thereafter.
Redemption proceeds (less any applicable contingent deferred sales charge
imposed on shareholders who purchased shares of the Fund of $1 million or more
without a front-end sales load and redeem such shares within 2 years after
purchase) will be wired to a correspondent member bank if the investor's
designated bank is not a member of the Federal Reserve System. Immediate
notification by the correspondent bank to the investor's bank is necessary to
avoid a delay in crediting the funds to the investor's bank account. Proceeds
of less than $1,000 will be mailed to the investor's address.
To change the commercial bank or account designated to receive
redemption proceeds, a written request must be sent to the Company, c/o Pacific
Horizon Funds, Inc., P.O. Box 80221, Los Angeles, California 90080-9909. Such
request must be signed by each shareholder, with each signature guaranteed as
described in the Fund's Prospectus. Guarantees must be signed by an authorized
signatory and "signature guaranteed" must appear with the signature. The
Transfer Agent may request further documentation from corporations, executors,
administrators, trustees or guardians, and will accept other suitable
verification arrangements from foreign investors, such as consular verification.
Investors in the Fund redeeming by Check generally will be subject to
the same rules and regulations that commercial banks apply to checking accounts,
although the election of this privilege creates only a shareholder-transfer
agent relationship with the Transfer Agent. An investor may deliver Checks
directly
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<PAGE> 325
to the Transfer Agent, BISYS Fund Services Ohio, Inc., 3435 Stelzer Road,
Columbus Ohio 43219-3035, in which case the proceeds will be mailed, wired or
made available at the Transfer Agent on the next business day. The Check
delivered to the Transfer Agent must be accompanied by a properly executed
stock power form on which the investor's signature is guaranteed as described
in the Fund's Prospectus.
Because dividends on the Fund accrue daily, Checks should not be used
to close an account, as a small balance is likely to result.
Check redemption may be modified or terminated at any time by the
Company or the Transfer Agent upon notice to shareholders.
SUPPLEMENTARY PURCHASE AND REDEMPTION INFORMATION:
In General. As described in the Prospectus, Fund shares may be
purchased directly by the public, by clients of Bank of America through their
qualified trust and agency accounts, or by clients of securities dealers,
financial institutions (including banks) and other industry professionals, such
as investment advisers, accountants and estate planning firms that have entered
into service and/or selling agreements with the Distributor. (The Distributor,
such institutions and professionals are collectively referred to as "Service
Organizations.") Bank of America and Service Organizations may impose minimum
customer account and other requirements in addition to those imposed by the Fund
and described in the Prospectus. Purchase orders will be effected only on
business days.
Shares in the Fund are sold with a sales load. However, there is no
front-end sales load on combined purchases of shares of $1 million or more.
Concord Financial Group, Inc. will pay commissions of up to 1.00% to brokers
whose customers purchase such shares. Additionally, a 1.00% and 0.50% contingent
deferred sales charge is applicable to shareholders who purchase shares of the
Fund of $1 million or more without a front-end sales load and redeem such shares
within one year and two years, respectively, after purchase. Service
Organizations may be paid by the Distributor at the Company's expense for
shareholder services. Depending on the terms of the particular account, Bank of
America, its affiliates, and Service Organizations also may charge their
customers fees for automatic investment, redemption and other services provided.
Such fees may include, for example, account maintenance fees, compensating
balance requirements or fees based upon account transactions, assets or income.
Bank of America or the particular Service Organization is responsible for
providing information concerning
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<PAGE> 326
these services and any charges to any customer who must authorize the purchase
of Fund shares prior to such purchase.
Persons wishing to purchase Company shares through their accounts at
Bank of America or a Service Organization should contact such entity directly
for appropriate instructions.
Initial purchases of shares into a new account may not be made by wire.
However, persons wishing to make a subsequent purchase of Company shares into an
already existing account by wire should telephone the Transfer Agent at (800)
346-2087. The investor's bank must be instructed to wire federal funds to the
Transfer Agent, referring in the wire to the Fund; the investor's portfolio
account number; and the investor's name.
For processing redemptions, the Transfer Agent may request further
documentation from corporations, executors, administrators, trustees or
guardians. The Transfer Agent will accept other suitable verification
arrangements from foreign investors, such as consular verification.
Investors should be aware that if they have selected the TeleTrade
Privilege, any request for a wire redemption will be effected as a TeleTrade
transaction through the Automated Clearing House (ACH) system unless more prompt
transmittal is specifically requested. Redemption proceeds of a TeleTrade
transaction will be on deposit in the investor's account at the ACH member bank
normally two business days after receipt of the redemption request.
Exchange Privilege. Shareholders in the Pacific Horizon Family of Funds
have an exchange privilege whereby they may exchange all or part of their
Pacific Horizon Shares for shares of other investment portfolios in the Pacific
Horizon Family of Funds. Shareholders may also exchange all or a part of their
Pacific Horizon Shares for like shares of an investment portfolio of Time
Horizon Funds. By use of the exchange privilege, the investor authorizes the
Transfer Agent to act on telephonic, telegraphic or written exchange
instructions from any person representing himself or herself to be the investor
and believed by the Transfer Agent to be genuine. The Transfer Agent's records
of such instructions are binding. The exchange privilege may be modified or
terminated at any time upon notice to shareholders. For federal income tax
purposes, exchange transactions are treated as sales on which a purchaser will
realize a capital gain or loss depending on whether the value of the shares
exchanged is more or less than his basis in such shares at the time of the
transaction.
Exchange transactions described in Paragraphs A, B, C and D below will
be made on the basis of the relative net asset
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<PAGE> 327
values per share of the investment portfolios involved in the transaction.
A. Shares of any investment portfolio purchased with a sales load, as
well as additional shares acquired through reinvestment of
dividends or distributions on such shares, may be exchanged
without a sales load for shares of any other investment portfolio
in the Pacific Horizon Family of Funds or the Time Horizon Funds.
B. Shares of any investment portfolio in the Pacific Horizon Family
of Funds or the Time Horizon Funds acquired by a previous exchange
transaction involving shares on which a sales load has directly or
indirectly been paid (e.g. shares purchased with a sales load or
issued in connection with an exchange transaction involving shares
that had been purchased with a sales load), as well as additional
shares acquired through reinvestment of dividends or distributions
on such shares, may be redeemed and the proceeds used to purchase
without a sales load shares of any other investment portfolio. To
accomplish an exchange transaction under the provisions of this
Paragraph, investors must notify the Transfer Agent of their prior
ownership of shares and their account number.
C. Shares of any investment portfolio in the Pacific Horizon Family
of Funds may be exchanged without a sales load for shares of any
other investment portfolio in the Family that is offered without a
sales load.
D. Shares of any investment portfolio in the Pacific Horizon Family
of Funds purchased without a sales load may be exchanged without a
sales load for shares in any other portfolio where the investor
involved maintained an account in the Pacific Horizon Family of
Funds before April 20, 1987 or was the beneficial owner of shares
of Bunker Hill Income Securities, Inc. on the date of its
reorganization into the Pacific Horizon Corporate Bond Fund.
Neither a contingent deferred sales charge nor a front-end sales load
will be imposed at the time of exchange if a shareholder purchases shares of
the Fund of $1 million or more without a front-end sales load and exchanges
such shares for shares of another investment portfolio of the Company or Time
Horizon Funds. However, shares acquired in the exchange are subject to a
contingent deferred sales charge of 1.00% and 0.50%, respectively, on
redemptions within one year and two years after purchase.
Except as stated above, a sales load will be imposed when shares of any
investment portfolio in the Pacific Horizon Family of Funds that were purchased
or otherwise acquired without a sales load are exchanged for shares of another
investment portfolio in the Pacific Horizon Family or the Time Horizon Funds
which are sold with a sales load.
Exchange requests received on a business day prior to the time shares
of the investment portfolios involved in the request are priced will be
processed on the date of receipt. "Processing" a request means that shares in
the investment
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<PAGE> 328
portfolio from which the shareholder is withdrawing an investment will be
redeemed at the net asset value per share next determined on the date of
receipt. Shares of the new investment portfolio into which the shareholder is
investing will also normally be purchased at the net asset value per share next
determined coincident to or after the time of redemption. Exchange requests
received on a business day after the time shares of the investment portfolios
involved in the request are priced will be processed on the next business day
in the manner described above.
Miscellaneous. Certificates for shares will not be issued.
Depending on the terms of the customer account at Bank of America or a
Service Organization, certain purchasers may arrange with the Company's
custodian for sub-accounting services paid by the Company without direct charge
to the purchaser.
A "business day" for purposes of processing share purchases and
redemptions received by the Transfer Agent at its Columbus office is a day on
which the New York Stock Exchange is open for trading. In 1996, the holidays on
which the New York Stock Exchange is closed are: New Year's Day, Presidents'
Day, Good Friday, Memorial Day (observed), Independence Day, Labor Day,
Thanksgiving Day and Christmas Day.
The Company may suspend the right of redemption or postpone the date of
payment for shares during any period when (a) trading on the New York Stock
Exchange is restricted by applicable rules and regulations of the Securities and
Exchange Commission; (b) the New York Stock Exchange is closed for other than
customary weekend and holiday closings; (c) the Securities and Exchange
Commission has by order permitted such suspension; or (d) an emergency exists as
determined by the Securities and Exchange Commission. (The Company may also
suspend or postpone the recordation of the transfer of its shares upon the
occurrence of any of the foregoing conditions.)
The Company's Charter permits its Board of Directors to require a
shareholder to redeem involuntarily shares in a Fund if the balance held of
record by the shareholder drops below $500 and such shareholder does not
increase such balance to $500 or more upon 60 days' notice. The Company will not
require a shareholder to redeem shares of the Fund if the balance held of record
by the shareholder is less than $500 solely because of a decline in the net
asset value of the Fund's shares. The Company may also redeem shares
involuntarily if such redemption is appropriate to carry out the Company's
responsibilities under the 1940 Act.
If the Company's Board of Directors determines that conditions exist
which make payment of redemption proceeds wholly
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<PAGE> 329
in cash unwise or undesirable, the Company may make payment wholly or partly in
securities or other property. Additionally, the Company has made an
undertaking to the State of Texas that it may only make payment of such
proceeds wholly or in part in "readily marketable" securities or other
property. (If the Company determines that such undertaking is no longer in its
best interests, it will revoke the commitment. In such an event, the Fund may
no longer be able to sell its shares in the State of Texas.) In such an event,
a shareholder would incur transaction costs in selling the securities or other
property. The Company has committed that it will pay all redemption requests
by a shareholder of record in cash, limited in amount with respect to each
shareholder during any ninety-day period to the lesser of $250,000 or 1% of the
net asset value at the beginning of such period.
ADDITIONAL INFORMATION CONCERNING TAXES
FEDERAL
The Fund will be treated as a separate corporate entity under the
Internal Revenue Code of 1986, as amended (the "Code"), and intends to qualify
as a "regulated investment company." By following this policy, the Fund expects
to eliminate or reduce to a nominal amount the federal income taxes to which it
may be subject. If for any taxable year the Fund does not qualify for the
special federal tax treatment afforded regulated investment companies, all of
the Fund's taxable income would be subject to tax at regular corporate rates
(without any deduction for distributions to shareholders). In such event, the
Fund's dividend distributions (including amounts derived from interest on
Municipal Securities i.e., exempt-interest dividends) to shareholders would be
taxable as ordinary income to the extent of the current and accumulated earnings
and profits of the Fund and would be eligible for the dividends received
deduction in the case of corporate shareholders.
Qualification as a regulated investment company under the Code
requires, among other things, that the Fund distribute to its shareholders an
amount equal to at least the sum of 90% of its investment company taxable income
(if any) and 90% of its tax-exempt income (if any), net of certain deductions
for each taxable year. The Fund's policy is to pay each year as exempt-interest
dividends substantially all the Fund's Municipal Securities interest income net
of certain deductions. An exempt-interest dividend is any dividend or part
thereof (other than a capital gain dividend) paid by the Fund and designated as
an exempt-interest dividend in a written notice mailed to shareholders after
the close of the Fund's taxable year. However, the aggregate amount of dividends
so designated by the Fund cannot exceed the excess of the amount of interest
exempt
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<PAGE> 330
from tax under Section 103 of the Code received by the Fund during the taxable
year over any amounts disallowed as deductions under Sections 265 and 171(a)(2)
of the Code. The percentage of total dividends paid for any taxable year which
qualifies as exempt-interest dividends will be the same for all shareholders
receiving dividends from the Fund for such year. In order for the Fund to pay
exempt-interest dividends for any taxable year, at the close of each quarter of
its taxable year at least 50% of the aggregate value of the Fund's assets must
consist of exempt-interest obligations.
Exempt-interest dividends may be treated by shareholders of the Fund as
items of interest excludable from their gross income under Section 103(a) of the
Code. However, each shareholder is advised to consult his or her tax adviser
with respect to whether exempt-interest dividends would retain the exclusion
under Section 103(a) if such shareholder would be treated as a "substantial
user" or a "related person" to such user with respect to facilities financed
through any of the tax-exempt obligations held by the Fund. A "substantial user"
is defined under U.S. Treasury Regulations to include a non-exempt person who
regularly uses a part of such facilities in his or her trade or business and
whose gross revenues derived with respect to the facilities financed by the
issuance of bonds are more than 5% of the total revenues derived by all users of
such facilities, or who occupies more than 5% of the usable area of such
facilities or for whom such facilities or a part thereof were specifically
constructed, reconstructed or acquired. A "related person" includes certain
related natural persons, affiliated corporations, partners and partnerships and
S corporations and their shareholders.
In general, the Fund's investment company taxable income will be its
taxable income subject to certain adjustments and excluding the excess of any
net long-term capital gain for the taxable year over the net short-term capital
loss, if any, for such year. The Fund will be taxed on its undistributed
investment company taxable income, if any.
The Fund will not be treated as a regulated investment company under
the Code if 30% or more of the Fund's gross income for a taxable year is derived
from gains realized on the sale or other disposition of the following
investments held for less than three months (the "Short-Short test"): (1) stock
and securities (as defined in section 2(a)(36) of the 1940 Act); (2) options,
futures and forward contracts other than those on foreign currencies; and (3)
foreign currencies (and options, futures and forward contracts on foreign
currencies) that are not directly related to a Fund's principal business of
investing in stock and securities (and options and futures with respect to
stocks and securities). Interest (including original issue discount and accrued
market discount) received by a Fund upon maturity or
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<PAGE> 331
disposition of a security held for less than three months will not be treated
as gross income derived from the sale or other disposition of such security
within the meaning of this requirement. However, any other income that is
attributable to realized market appreciation will be treated as gross income
from the sale or other disposition of securities for this purpose. See
Appendix B -- "Accounting and Tax Treatment" for a general discussion of the
federal tax treatment of futures contracts, related options thereon and other
financial instruments, including their treatment under the Short-Short test.
Any distribution of the excess of net long-term capital gains over net
short-term capital losses is taxable to shareholders as long-term capital gains,
regardless of how long the shareholder has held the Fund's shares and whether
such gains are received in cash or additional Fund shares. The Fund will
designate such a distribution as a capital gain dividend in a written notice
mailed to shareholders after the close of the Fund's taxable year.
A 4% non-deductible excise tax is imposed on regulated investment
companies that fail currently to distribute specific percentages of their
ordinary taxable income and capital gain net income (excess of capital gains
over capital losses). The Fund intends to make sufficient distributions or
deemed distributions of its ordinary taxable income and any capital gain net
income prior to the end of each calendar year to avoid liability for this excise
tax.
The Company 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 upon sale paid to shareholders (i) who have failed to provide either a
correct tax identification number in the manner provided, (ii) who are subject
to withholding by the Internal Revenue Service for failure to properly include
on their return payments of taxable interest or dividends, or (iii) who have
failed to certify to the Company either that they are subject to backup
withholding when they are required to do so or that they are "exempt
recipients."
At February 28, 1995, the Fund had capital loss carryforwards of
$3,632, which will expire in fiscal 2003. To the extent provided by the
regulations in the Code, these capital loss carryforwards will be used to offset
future capital gains on securities transactions. As such, it is probable that
the gains so offset will not be distributed to shareholders.
TAXATION OF THE PORTFOLIO
Management of the Portfolio intends for the Portfolio to be treated as
a partnership rather than as a regulated investment company or a corporation
under the Code. As a
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<PAGE> 332
partnership under the Code, any interest, dividends, gains and losses of the
Portfolio will be deemed to have been "passed through" to its investors
regardless whether any amounts are actually distributed by the Portfolio.
Each investor in the Portfolio will be taxed on its share (as
determined in accordance with the governing instruments of the Portfolio) of the
Portfolio's ordinary income and capital gains in determining its income tax
liability. The determination of such share will be made in accordance with the
Code and regulations promulgated thereunder. It is intended that the Portfolio's
assets, income and distributions will be managed in such a way that an investor
in the Portfolio will be able to satisfy Code requirements applicable to
regulated investment companies, assuming that the investor invested all of its
assets in the Portfolio.
OTHER INFORMATION
Depending upon the extent of 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, the
Fund may be subject to the tax laws of such states or localities.
Because state and local tax consequences may be different from the
Federal tax consequences described above, shareholders are advised to consult
their tax advisers concerning the application of state and local taxes.
The foregoing discussion is based on tax laws and regulations which are
in effect on the date of this Statement of Additional Information. Such laws and
regulations may be changed by legislative or administrative action. This
discussion is only a summary of some of the important tax considerations
generally affecting purchasers of Fund shares. No attempt is made to present a
detailed explanation of the federal income tax treatment of the Funds or their
shareholders, and this discussion is not intended as a substitute for careful
tax planning. Accordingly, potential purchasers of Fund shares should consult
their tax advisers with specific reference to their own tax situation.
MANAGEMENT
DIRECTORS AND OFFICERS OF THE COMPANY
The directors and officers of the Company, their addresses, ages and
principal occupations during the past five years are:
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<PAGE> 333
<TABLE>
<CAPTION>
Position with
Name and Address Age Company Principal Occupations
- ---------------- --- ------- ---------------------
<S> <C> <C> <C>
Thomas M. Collins 61 Director Of counsel, law firm of
McDermott & Trayner McDermott & Trayner;
225 S. Lake Avenue Partner of the law firm
Suite 410 of Musick, Peeler &
Pasadena, CA 91101-3005 Garrett (until April,
1993); Trustee, Master
Investment Trust Series I
and Master Investment
Trust, Series II
(registered investment
companies) (since 1993);
former Director, Bunker
Hill Income Securities,
Inc. (registered
investment company)
through 1991.
Douglas B. Fletcher 70 Vice Chairman Chairman of the Board and
Fletcher Capital of the Board Chief Executive Officer,
Advisors Incorporated Fletcher Capital
4 Upper Newport Plaza Advisors, Incorporated,
Suite 100 (registered investment
Newport Beach, CA 92660-2629 adviser) 1991 to date;
Partner, 1991 Newport
Partners (private venture
capital firm), 1981 to
date; Chairman of the
Board and Chief Executive
Officer, First Pacific
Advisors, Inc.
(registered investment
adviser) and seven
investment companies
under its management,
prior to 1983; former
Allied Member, New York
Stock Exchange; Chairman
of the Board of FPA
Paramount Fund, Inc.
through 1984; Director,
TIS Mortgage Investment
Company (real estate
investment trust);
Trustee and former Vice
Chairman of the Board,
Clare mont McKenna
College; Chartered
Financial Analyst.
Robert E. Greeley 62 Director Chairman, Page Mill
Page Mill Asset Asset Management (a
Management private investment
433 California Street company) since 1991;
Suite 900 Manager, Corporate
San Francisco, CA 94104 Investments, Hewlett
Packard Company from
</TABLE>
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<PAGE> 334
<TABLE>
<CAPTION>
Position with
Name and Address Age Company Principal Occupations
- ---------------- --- ------- ---------------------
<S> <C> <C> <C>
1979 to 1991; Trustee,
Master Investment Trust,
Series I and Master
Investment Trust, Series
II (since 1993);
Director, Morgan Grenfell
Small Cap Fund (since
1986); former Director,
Bunker Hill Income
Securities, Inc. (since
1989) (registered
investment companies);
former Trustee,
SunAmerica Fund Group
(previously Equitec
Siebel Fund Group) from
1984 to 1992.
Kermit O. Hanson 79 Director Vice Chairman of the
17760 14th Ave., N.W. Advisory Board, 1988 to
Seattle, WA 98177 date, Executive Director,
1977 to 1988, Pacific Rim
Bankers Program (a
non-profit educational
institution); Dean
Emeritus, 1981 to date,
Dean, 1964-81, Graduate
School of Business
Administration,
University of Washington;
Director, Washington
Federal Savings & Loan
Association; Trustee,
Seafirst Retirement Funds
(since 1993) (registered
investment company).
Cornelius J. Pings* 66 Chairman of President, Association of
Association of American the Board and American Universities,
Universities President February 1993 to date;
One DuPont Circle Provost, 1982 to January
Suite 730 1993, Senior Vice
Washington, DC 20036 President for Academic
Affairs, 1981 to January
1993, University of
Southern California;
Trustee, Master
Investment Trust, Series
I and Master Investment
Trust, Series II (since
1995).
</TABLE>
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<PAGE> 335
<TABLE>
<CAPTION>
Position with
Name and Address Age Company Principal Occupations
- ---------------- --- ------- ---------------------
<S> <C> <C> <C>
Kenneth L. Trefftzs 83 Director Private Investor;
11131 Briarcliff Drive formerly Distinguished
San Diego, CA 92131-1329 Emeritus Professor of
Finance and Chairman of
the Department of Finance
and Business Economics of
the Graduate School of
Business of the
University of Southern
California; former
Director, Metro Goldwyn
Mayer, Inc.; Director,
Fremont General
Corporation (insurance
and financial services
holding company);
Director, Source Capital,
Inc. (closed-end
investment company);
Director of three
open-end investment
companies managed by
First Pacific Advisors,
Inc.; formerly Chairman
of the Board of Directors
(or Trustees) of nineteen
investment companies
managed by American
Capital Asset Management,
Inc.
Richard E. Stierwalt 40 Executive Chairman of the Board and
125 W. 55th Street Vice President Chief Executive Officer,
New York, NY 10019 July 1993 to date, prior
thereto Senior Director,
Managing Director and
Chief Executive Officer
of the Administrator and
Distributor, February
1987 to July 1993;
President, Master
Investment Trust, Series
I, Master Investment
Trust, Series II and
Seafirst Retirement Funds
(since 1993); First Vice
President, Trust
Operation Administration,
Security Pacific National
Bank, 1983-1987.
</TABLE>
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<PAGE> 336
<TABLE>
<CAPTION>
Position with
Name and Address Age Company Principal Occupations
- ---------------- --- ------- ---------------------
<S> <C> <C> <C>
William B. Blundin 57 Executive Vice Vice Chairman, July 1993
125 W. 55th Street President to date, prior thereto
New York, NY 10019 Director and President of
the Administrator and
Distributor, February
1987 to July 1993;
Executive Vice President,
Master Investment Trust,
Series II and Seafirst
Retirement Funds (since
1993); Senior Vice
President, Shearson
Lehman Brothers,
1978-1987.
Irimga McKay 35 Vice Senior Vice President,
7863 Girard Avenue President July 1993 to date, prior
Suite 306 thereto First Vice
La Jolla, CA 92037 President of the
Administrator and
Distributor, November
1988 to July 1993; Vice
President, Master
Investment Trust, Series
II and Seafirst
Retirement Funds (since
1993); Regional Vice
President, Continental
Equities, June 1987 to
November 1988; Assistant
Wholesaler, VMS Realty
Partners (a real estate
limited partnership), May
1986 to June 1987.
W. Eugene Spurbeck 39 Assistant Vice Manager of Client
BISYS Fund Services President Services of the
515 Figueroa Street Administrator (1993 to
Suite 335 date); Assistant Vice
Los Angeles, CA 92307 President, Master
Investment Trust, Series
II; Vice President,
Seafirst Retirement Funds
(since 1995); Vice
President of Retail
Lending Operations Banc
One (1989 to 1993).
Martin R. Dean 31 Treasurer Manager of Fund
3435 Stelzer Road Accounting of BISYS Fund
Columbus, OH 43219 Services, May 1994 to
Present; Treasurer,
Master Investment Trust,
Series II and Seafirst
Retirement Funds (since
1995); Senior Manager at
</TABLE>
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<PAGE> 337
<TABLE>
<CAPTION>
Position with
Name and Address Age Company Principal Occupations
- ---------------- --- ------- ---------------------
<S> <C> <C> <C>
KPMG Peat Marwick
previously 1990-1994.
W. Bruce McConnel, III 52 Secretary Partner of the law firm
1345 Chestnut Street of Drinker Biddle &
Philadelphia National Bank Reath. Secretary,
Building, Suite 1100 Master Investment Trust,
Philadelphia, PA 19107 Series I, Master
Investment Trust, Series
II and Seafirst
Retirement Funds
George O. Martinez 35 Assistant Senior Vice President and
3435 Stelzer Road Secretary Director of Legal and
Columbus, OH 43219 Compliance Services, of
the Administrator. since
April 1995; Assistant
Secretary, Master
Investment Trust, Series
II and Seafirst
Retirement Funds (since
1995); prior thereto,
Vice President and
Associate General
Counsel, Alliance Capital
Management, L.P.
</TABLE>
- --------------
* Mr. Pings is an "interested director" of the Company as defined in the 1940
Act.
The Audit Committee of the Board is comprised of all directors and is
chaired by Dr. Trefftzs. The Board does not have an Executive Committee.
Each director is entitled to receive an annual fee of $25,000 plus
$1,000 for each day that a director participates in all or a part of a Board
meeting; the President receives an additional $20,000 per annum for his services
as President; Mr. Collins, in consideration of his years of service as President
and Chairman of the Board, receives an additional $40,000 per annum in severance
until February 28, 1997; each member of a Committee of the Board is entitled to
receive $1,000 for each Committee meeting they participate in (whether or not
held on the same day as a Board meeting); and each Chairman of a Committee of
the Board shall be entitled to receive an annual retainer of $1,000 for his
services as Chairman of the Committee. The Fund, and each other fund of the
Company, pays its proportionate share of these amounts based on relative net
asset values.
-29-
<PAGE> 338
For the fiscal year ended February 28, 1995, the Company paid or
accrued for the account of its directors as a group for services in all
capacities a total of $334,168. Of that amount, $27,065 was allocated to the
Fund. Each director is also reimbursed for out-of-pocket expenses incurred as a
director. Drinker Biddle & Reath, of which Mr. McConnel is a partner, receives
legal fees as counsel to the Company. As of the date of this Statement of
Additional Information, the directors and officers of the Company, as a group,
own less than 1% of the outstanding shares of each of the Company's investment
portfolios.
Under a retirement plan approved by the Board, including a majority of
its directors who are not "interested persons" of the Company, effective March
1, 1995, a director who dies or resigns after five years of service is entitled
to receive ten annual payments each equal to the greater of: (i) 50% of the
annual director's retainer that was payable by the Company during the year of
his/her death or resignation, or (ii) 50% of the annual director's retainer then
in effect for directors of the Company during the year of such payment. A
director who dies or resigns after nine years of service is entitled to receive
ten annual payments each equal to the greater of: (i) 100% of the annual
director's retainer that was payable by the Company during the year of his/her
death or resignation, or (ii) 100% of the annual director's retainer then in
effect for directors of the Company during the year of such payment. Further,
the amount payable each year to a director who dies or resigns is increased by
$1,000 for each year of service that the director provided as Chairman of the
Board.
Years of service for purposes of calculating the benefit described
above are based upon service as a director or Chairman after February 28, 1994.
Retirement benefits in which a director has become vested may not be reduced by
later Board action.
In lieu of receiving ten annual payments, a director may elect to
receive substantially equivalent benefits through a single-sum cash payment of
the present value of such benefits paid by the Company within 45 days of the
death or resignation of the director. The present value of such benefits is to
be calculated (i) based on the retainer that was payable by the Company during
the year of the director's death or resignation (and not on any retainer payable
to directors thereafter), and (ii) using the interest rate in effect as of the
date of the director's death or resignation by the Pension Benefit Guaranty
Corporation (or any successor thereto) for valuing immediate annuities under
terminating defined benefit pension plans. A director's election to receive a
single sum must be made in writing within the 30 calendar days after the date
the individual is first elected as a director.
-30-
<PAGE> 339
In addition to the foregoing, the Board of Directors may, in its
discretion and in recognition of a director's period of service before March 1,
1994 as a director and possibly as Chairman, authorize the Company to pay a
retirement benefit following the director's death or resignation (unless the
director has vested benefits as a result of completing nine years of service).
Any such action shall be approved by the Board and by a majority of the
directors who are not "interested persons" of the Company within 120 days
following the director's death or resignation and may be authorized as a single
sum cash payment or as not more than ten annual payments (beginning the first
anniversary of the director's date of death or resignation and continuing for
one or more anniversary date(s) thereafter).
The obligation of the Company to pay benefits to a former director is
neither secured nor funded by this Company but shall be binding upon its
successors in interest. The payment of such benefits under the retirement plan
has no priority or preference over the lawful claims of the Company's creditors
or shareholders, and the right to receive such payments is not assignable or
transferable by a director (or former director) other than by will, by the laws
of descent and distribution, or by the director's written designation of a
beneficiary.
TRUSTEES AND OFFICERS OF MASTER INVESTMENT TRUST, SERIES II
The trustees and officers of Master Investment Trust, Series II (the
"Master Trust"), a Delaware business trust of which the Portfolio is a series,
their addresses, ages and principal occupation during the past five years are:
<TABLE>
<CAPTION>
Position with
Name and Address Age Company Principal Occupation
- ---------------- --- ------- --------------------
<S> <C> <C> <C>
Thomas M. Collins 61 Chairman of the Board See "Directors and
McDermott & Trayner Officers of the
225 S. Lake Avenue, Company."
Suite 410
Pasadena, CA 91101-3005
Michael Austin 59 Trustee Chartered Accountant;
Victory House, Trustee, Master Investment
Nelson Quay Trust, Series I (since
Governor's Harbor 1993); Retired Partner,
Grand Cayman KPMG Peat Marwick LLP.
Cayman Islands
British West Indies
Robert E. Greeley 62 Trustee See "Directors and
Page Mill Asset Officers of
Management the Company."
433 California Street
Suite 900
San Francisco, CA 94101
</TABLE>
-31-
<PAGE> 340
<TABLE>
<CAPTION>
Position with
Name and Address Age Company Principal Occupations
- ---------------- --- ------- ---------------------
<S> <C> <C> <C>
Robert A. Nathane* 70 Trustee Retired President, Laird
1200 Shenandoah Drive Norton Trust Company,
East Chairman of the Board of
Seattle, WA 98112 Advisors, Phoenix Venture
Funds; Trustee, Master
Investment Trust, Series I
(since 1993); Trustee,
Seafirst Retirement Funds
(since 1993); former
Supervisor, Collective
Investment Trust for
Seafirst Retirement
Accounts; former Trustee,
First Funds of America
(registered investment
companies).
Cornelius J. Pings 66 Trustee See "Directors and
Association of American Officers of the
Universities Company."
One DuPont Circle
Suite 730
Washington, DC 20036
Richard E. Stierwalt 40 President See "Directors and
125 West 55th Street Officers of the
New York, NY 10019 Company."
William B. Blundin 57 Executive Vice President See "Directors and
125 West 55th Street Officers of the
New York, NY 10019 Company."
Irimga McKay 35 Vice President See "Directors and
7863 Girard Avenue Officers of the
Suite 306 Company."
La Jolla, CA 92037
W. Eugene Spurbeck 39 Assistant See "Directors and
BISYS Fund Services Vice President Officers of the
515 Figueroa Street Company."
Suite 335
Los Angeles, CA 92307
W. Bruce McConnel, III 52 Secretary See "Directors and
1345 Chestnut Street Officers of the
Philadelphia, PA 19107 Company."
Martin R. Dean 31 Treasurer See "Directors and
3435 Stelzer Road Officers of the
Columbus, OH 43219 Company."
George O. Martinez 35 Assistant Secretary See "Directors and
3435 Stelzer Road Officers of the
Columbus, OH 43219 Company."
</TABLE>
- --------------
* Mr. Nathane is an "interested trustee" of the Master Trust as defined in the
1940 Act.
-32-
<PAGE> 341
Each trustee receives an aggregate annual fee of $1,500 plus $500 per
meeting attended and $250 per day for each full day devoted to travel in
connection with each meeting attended, for his services as trustee of the
Portfolio. Each trustee is also reimbursed for out-of-pocket expenses incurred
as a trustee. Drinker Biddle & Reath, of which Mr. McConnel is a partner,
receives legal fees as counsel to the Trust. The trustees and officers of the
Master Trust, as a group, own less than 1% of the outstanding shares of the
Portfolio.
The following chart provides certain information about the
director/trustee fees of the Company's and Master Trust's directors/trustees as
of February 28, 1995:
<TABLE>
<CAPTION>
TOTAL
COMPENSATION
PENSION OR FROM
RETIREMENT ESTIMATED REGISTRANT
AGGREGATE AGGREGATE BENEFITS ANNUAL AND FUND
COMPENSATION COMPENSATION ACCRUED AS BENEFITS COMPLEX*
NAME OF PERSON/ FROM THE FROM THE PART OF FUND UPON PAID TO
POSITION COMPANY MASTER TRUST EXPENSES RETIREMENT DIRECTORS
- -------- ------- ------------ -------- ---------- ---------
<S> <C> <C> <C> <C> <C>
Thomas M. Collins $100,000 $5,000 $0 $0 $110,000
President and
Chairman of the
Board+
Douglas B. Fletcher $ 57,500 $ 0 $0 $0 $ 57,500
Vice Chairman of
the Board
Robert E. Greeley** $ 57,500 $4,031 $0 $0 $ 65,781
Director
Kermit O. Hanson $ 57,500 $ 0 $0 $0 $ 63,500
Director
Cornelius J. Pings $ 57,500 $ 0 $0 $0 $ 57,500
Director
Kenneth L. Trefftzs $ 57,500 $ 0 $0 $0 $ 57,500
Director
</TABLE>
- --------------
* The "Fund Complex" consists of the Company, Seafirst Retirement Funds, the
Master Trust and Master Investment Trust, Series I.
** Mr. Greeley became a director of the Company on April 25, 1994.
+ Mr. Colllins was President and Chairman of the Board of the Company until
August 31, 1995.
-33-
<PAGE> 342
INVESTMENT ADVISOR
Bank of America is the successor by merger to Security Pacific National
Bank ("Security Pacific"), which previously served as investment adviser to the
other investment portfolios of the Company since the commencement of its
operations. As described in the Prospectus, the Fund has not retained the
services of an investment adviser since it seeks to achieve its investment
objective by investing all of its assets in the Portfolio. In the Investment
Advisory Agreement with the Master Trust, Bank of America has agreed to provide
investment advisory services as described in the Prospectus. Bank of America has
also agreed to pay all expenses incurred by it in connection with its activities
under its agreements other than the cost of securities, including brokerage
commissions, if any, purchased for the Portfolio. In rendering its advisory
services, Bank of America may utilize Bank officers from one or more of the
departments of the Bank which are authorized to exercise the fiduciary powers of
Bank of America with respect to the investment of trust assets. In some cases,
these officers may also serve as officers, and utilize the facilities, of
wholly-owned subsidiaries and other affiliates of Bank of America or its parent
corporation. For the services provided and expenses assumed pursuant to the
Investment Advisory Agreement for the Portfolio, the Master Trust has agreed to
pay Bank of America fees, accrued daily and payable monthly, at the annual rate
of .35% of the average net assets of the Portfolio.
For the fiscal year ended February 28, 1995, Bank of America waived its
entire investment advisory fee of $6,147, assumed certain operating expenses of
the Portfolio in the amount of $121,591, and assumed certain operating expenses
of the Fund in the amount of $180,700.
For the period from January 28, 1994 (commencement of operations)
through February 28, 1994, Bank of America waived its entire investment advisory
fees of $108, assumed certain operating expenses of the Portfolio in the amount
of $34,404, and assumed certain operating expenses of the Fund in the amount of
$18,272. The fees payable to Bank of America are not subject to reduction as the
value of the Portfolio's net assets increases. From time to time, Bank of
America may waive fees or reimburse the Company or the Portfolio for expenses
voluntarily or as required by certain state securities laws. See "Management -
Administrator" for instances where the Fund's Administrator is required to make
expense reimbursements to the Company.
The Investment Advisory Agreement for the Portfolio provides that Bank
of America shall not be liable for any error of judgment or mistake of law or
for any loss suffered in connection with the performance of the Investment
Advisory Agreement, except a loss resulting from a breach of fiduciary
-34-
<PAGE> 343
duty with respect to the receipt of compensation for services or a loss
resulting from willful misfeasance, bad faith or negligence in the performance
of its duties or from reckless disregard by it of its duties and obligations
thereunder.
THE GLASS-STEAGALL ACT AND PROPOSED LEGISLATION
The Glass-Steagall Act, among other things, prohibits banks from
engaging in the business of underwriting securities, although national and
state-chartered banks generally are permitted to purchase and sell securities
upon the order and for the account of their customers. In 1971, the United
States Supreme Court held in Investment Company Institute v. Camp that the
Glass-Steagall Act prohibits a national bank from operating a fund for the
collective investment of managing agency accounts. Subsequently, the Board of
Governors of the Federal Reserve System (the "Board") issued a regulation and
interpretation to the effect that the Glass-Steagall Act and such decision
forbid a bank holding company registered under the Federal Bank Holding Company
Act of 1956 (the "Holding Company Act") or any non-bank affiliate thereof from
sponsoring, organizing or controlling a registered, open-end investment company
continuously engaged in the issuance of its shares, but do not prohibit such a
holding company or affiliate from acting as investment adviser, transfer agent
and custodian to such an investment company. In 1981, the United States Supreme
Court held in Board of Governors of the Federal Reserve System v. Investment
Company Institute that the Board did not exceed its authority under the Holding
Company Act when it adopted its regulation and interpretation authorizing bank
holding companies and their non-bank affiliates to act as investment advisers to
registered closed-end investment companies.
Bank of America believes that if the question was properly presented, a
court should hold that Bank of America may perform the services for the
Portfolio contemplated by the Investment Advisory Agreement, the Prospectus, and
this Statement of Additional Information without violation of the Glass-Steagall
Act or other applicable banking laws or regulations. It should be noted,
however, that there have been no cases deciding whether a national bank may
perform services comparable to those performed by Bank of America and that
future changes in either federal or state statutes and regulations relating to
permissible activities of banks or trust companies and their subsidiaries or
affiliates, as well as further judicial or administrative decisions or
interpretations of present and future statutes and regulations, could prevent
Bank of America from continuing to perform such services for the Portfolio or
from continuing to purchase Fund shares for the accounts of its customers.
-35-
<PAGE> 344
For a discussion of the Glass-Steagall Act in connection with the
Company's Shareholder Service Plan, see "Plan Payments" in the Fund's
Prospectus.
On the other hand, as described herein, the Fund is currently
distributed by Concord Financial Group, Inc., and Concord Holding Corporation,
its parent, provides the Fund with administrative services. If current
restrictions under the Glass-Steagall Act preventing a bank from sponsoring,
organizing, controlling, or distributing shares of an investment company were
relaxed, the Portfolio and the Company expect that Bank of America would
consider the possibility of offering to perform some or all of the services now
provided by Concord Holding Corporation or Concord Financial Group, Inc. From
time to time, legislation modifying such restriction has been introduced in
Congress which, if enacted, would permit a bank holding company to establish a
non-bank subsidiary having the authority to organize, sponsor and distribute
shares of an investment company. If this or similar legislation were enacted,
the Portfolio and the Company expect that Bank of America's parent bank holding
company would consider the possibility of one of its non-bank subsidiaries
offering to perform some or all of the services now provided by Concord Holding
Corporation or Concord Financial Group, Inc. It is not possible, of course, to
predict whether or in what form such legislation might be enacted or the terms
upon which Bank of America or such a non-bank affiliate might offer to provide
services for consideration by the Portfolio's Board of Trustees or the Company's
Board of Directors.
ADMINISTRATOR
Concord Holding Corporation (the "Administrator"), with offices at 125
W. 55th Street, New York, New York 10019 and 3435 Stelzer Road, Columbus, Ohio
43219, is a wholly-owned subsidiary of The BISYS Group, Inc. The Administrator
also serves as administrator to several other investment companies.
The Administrator provides administrative services to the Company and
the Portfolio as described in the Fund's Prospectus pursuant to separate
administration agreements for the Company and the Portfolio. The Portfolio's
administration agreement will continue in effect until October 31, 1996, and
thereafter for successive periods of one year, provided the agreement is not
sooner terminated. The Portfolio's administration agreement is terminable at any
time by the Portfolio's Board of Trustees or by a vote of a majority of the
Portfolio's outstanding interests upon 60 days' notice to the Administrator, or
by the Administrator upon 90 days' notice to the Portfolio. The Fund's
administration agreement will continue in effect until October 31, 1996 and
thereafter will be extended for successive periods of one year, provided that
each such extension is specifically approved (a) by vote of a majority of
-36-
<PAGE> 345
those members of the Company's Board of Directors who are not interested
persons of any party to the agreement, cast in person at a meeting called for
the purpose of voting on such approval, and (b) the Company's Board of
Directors or by vote of a majority of the outstanding voting securities of the
Fund. The agreement is terminable at any time without penalty by the Company's
Board of Directors or by a vote of a majority of the Fund's outstanding shares
upon 60 days' notice to the Administrator, or by the Administrator upon 90
days' notice to the Company.
The Company has agreed to pay the Administrator a fee for its services
as Administrator, accrued daily and payable monthly, at the annual rates of .15%
of the average net assets of the Fund, and .05% of the average net assets of the
Portfolio. The fees payable to the Administrator are not subject to reduction as
the value of the Fund's and the Portfolio's net assets increases. From time to
time, the Administrator may waive fees or reimburse the Company and Portfolio
for expenses, either voluntarily or as required by certain state securities
laws.
For the fiscal year ended February 28, 1995, the Administrator waived
the administration fees due from the Portfolio and the Fund in the amounts of
$896 and $2,720, respectively.
For the period from January 28, 1994 (commencement of operations)
through February 28, 1994, the Administrator waived the administration fees due
from the Portfolio and the Fund in the amounts of $15 and $46, respectively.
If total expenses borne by the Fund in any fiscal year exceed the
expense limitations imposed by applicable state securities regulations, the
Company and the Master Trust may deduct from the payments to be made with
respect to the Fund and the Portfolio to Bank of America and the Administrator,
respectively, or Bank of America and the Administrator each will bear, the
amount of such excess to the extent required by such regulations in proportion
to the fees otherwise payable to them for such year. Such amount, if any, will
be estimated, reconciled and effected or paid, as the case may be, on a monthly
basis. As of the date of this Statement of Additional Information, the most
restrictive expense limitation that may be applicable to the Company limits
aggregate annual expenses with respect to the Fund (including management,
advisory fees and the Fund's pro rata shares of such expenses of the Portfolio,
but excluding interest, taxes, brokerage commissions, and certain other
expenses) to 2-1/2% of the first $30 million of its average daily net assets, 2%
of the next $70 million, and 1-1/2% of its remaining average daily net assets.
During the course of the Company's fiscal year, the Administrator and Bank of
America may assume certain expenses and/or not receive payment of fees of the
Fund or Portfolio, while retaining the ability to be reimbursed
-37-
<PAGE> 346
by the Fund or Portfolio for such amounts prior to the end of the fiscal year.
This will have the effect of increasing yield to investors at the time such
fees are not received or amounts are assumed and decreasing yield when such
fees or amounts are reimbursed.
The Administrator will bear all expenses in connection with the
performance of its services under the administration agreements with the
exception of the fees charged by PFPC, Inc. for certain fund accounting services
which are borne by the Fund and the Portfolio. Expenses borne by the Fund and/or
Portfolio include taxes, interest, brokerage fees and commissions, if any, fees
of Board members who are not officers, directors, partners, employees or holders
of 5% or more of the outstanding voting securities of Bank of America or the
Administrator or any of their affiliates, Securities and Exchange Commission
fees and state securities qualification fees, advisory fees, administration
fees, charges of custodians, transfer and dividend disbursing agents' fees,
certain insurance premiums, outside auditing and legal expenses, costs of
maintaining corporate existence, costs attributable to investor services,
including without limitation telephone and personnel expenses, costs of
preparing and printing prospectuses and Statements of Additional Information for
regulatory purposes, cost of shareholders' reports and corporate meetings and
any extraordinary expenses. Certain shareholder servicing fees in connection
with the Company's shares are also paid by the Company. See "Distributor and
Plan Payments."
The administration agreements provide that the Administrator shall not
be liable for any error of judgment or mistake of law or any loss suffered by
the Company or the Portfolio in connection with the performance of the
administration agreements, except a loss resulting from willful misfeasance, bad
faith or negligence in the performance of its duties or from the reckless
disregard by it of its obligations and duties thereunder.
DISTRIBUTOR AND PLAN PAYMENTS
Concord Financial Group, Inc. (the "Distributor"), a wholly-owned
subsidiary of the Administrator, acts as distributor of the shares of the
Company. Shares are sold on a continuous basis by the Distributor. The
Distributor has agreed to use its best efforts to solicit orders for the sale of
the Company's shares although it is not obliged to sell any particular amount of
shares. The distribution agreement shall continue in effect until October 31,
1996. Thereafter, if not terminated, the distribution agreement shall continue
automatically for successive terms of one year, provided that such continuance
is specifically approved at least annually (a) by a vote of a
-38-
<PAGE> 347
majority of those members of the Board of Directors of the Company who are not
parties to the distribution agreement or "interested persons" of any such
party, cast in person at a meeting called for the purpose of voting on such
approval, and (b) by the Board of Directors of the Company or by vote of a
"majority of the outstanding voting securities" of the Fund as to which the
distribution agreement is effective; provided, however, that the distribution
agreement may be terminated by the Company at any time, without the payment of
any penalty, by vote of a majority of the entire Board of Directors of the
Company or by a vote of a "majority of the outstanding voting securities" of
the Fund on 60 days' written notice to the Distributor, or by the Distributor
at any time, without the payment of any penalty, on 90 days' written notice to
the Company. The agreement will automatically and immediately terminate in the
event of its "assignment."
For the fiscal year ended January 28, 1995, the Distributor received
$85,535 in sales loads in connection with share purchases, of which the
Distributor and various affiliates of Bank of America retained $9,400 and
$74,860, respectively. The balance was paid to selling dealers.
For the period from January 28, 1994 (commencement of the Fund's
operations) through February 28, 1994, the Distributor received $23,828 in sales
loads in connection with share purchases, of which the Distributor and various
affiliates of Bank of America retained $2,650 and $21,178, respectively. The
balance was paid to selling dealers.
The Distributor is entitled to payment by the Company for certain
shareholder servicing expenses in addition to the sales loads described above
and in the Prospectus under the Shareholder Service Plan (the "Plan") adopted by
the Company. Under the Shareholder Service Plan, the Company pays the
Distributor, with respect to the Fund, for (a) non-distribution shareholder
services provided by the Distributor to Service Organizations and/or the
beneficial owners of Fund shares, including, but not limited to shareholder
servicing provided by the Distributor at facilities dedicated for Company use,
provided such shareholder servicing is not duplicative of the servicing
otherwise provided on behalf of the Fund, and (b) fees paid to Service
Organizations (which may include the Distributor itself) for the provision of
support service to the shareholders for whom the Service Organization is the
dealer of record or holder of record or with whom the Servicing Organization has
a servicing relationship ("Clients").
Support services provided by Service Organizations may include, among
other things: (i) establishing and maintaining accounts and records relating to
Clients that invest in Fund shares; (ii) processing dividend and distribution
payments from
-39-
<PAGE> 348
the Fund on behalf of Clients; (iii) providing information periodically to
Clients regarding their positions in shares; (iv) arranging for bank wires; (v)
responding to Client inquiries concerning their investments in Fund shares;
(vi) providing the information to the Fund necessary for accounting or
subaccounting; (vii) if required by law, forwarding shareholder communications
from the Fund (such as proxies, shareholder reports, annual and semi-annual
financial statements and dividend, distribution and tax notices) to Clients;
(viii) assisting in processing exchange and redemption requests from Clients;
(ix) assisting Clients in changing dividend options, account designations and
addresses; and (x) providing such other similar services.
The Shareholder Service Plan provides that the Distributor is entitled
to receive payments for expenses on a monthly basis, at an annual rate not
exceeding .25% of the average daily net assets of the Fund during such month for
shareholder servicing expenses. The calculation of a Fund's average daily net
assets for these purposes does not include assets held in accounts opened via a
transfer of assets from trust and agency accounts of Bank of America. Further,
payments made out of or charged against the assets of the Fund must be in
payment for expenses incurred on behalf of the Fund.
If in any month the Distributor expends or is due more monies than can
be immediately paid due to the percentage limitation described above, the unpaid
amount is carried forward from month to month while the Plan is in effect until
such time, if ever, when it can be paid in accordance with such percentage
limitations. Conversely, if in any month the Distributor does not expend the
entire amount then available under the Plan, and assuming that no unpaid amounts
have been carried forward and remain unpaid, then the amount not expended will
be a credit to be drawn upon by the Distributor to permit future payment.
However, any unpaid amounts or credits due under the Plan may not be "carried
forward" beyond the end of the fiscal year in which such amounts or credits due
are accrued.
For the fiscal year ended February 28, 1995, and for the period
January 28, 1994 (commencement of operations) through February 28, 1994, the
Distributor waived all shareholder servicing fees in the amounts of $4,533 and
$77, respectively.
Payments for shareholder service expenses under the Shareholder
Service Plan are not subject to Rule 12b-1 (the "Rule") under the 1940 Act.
Pursuant to the Shareholder Service Plan, the Distributor provides that a report
of the amounts expended under the Plan, and the purposes for which such
expenditures were incurred, will be made to the Board of Directors for its
review at least quarterly. In addition, the Plan provides that the selection
and nomination of the directors
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<PAGE> 349
of the Company who are not "interested persons" of the Company have been
committed to the discretion of the directors who are neither "interested
persons" (as defined in the 1940 Act) of the Company nor have any direct or
indirect financial interest in the operation of the Shareholder Service Plan
(or related servicing agreements) (the "Non-Interested Plan Directors").
The Company's Board of Directors has concluded that there is a
reasonable likelihood that the Plan will benefit the Fund and its shareholders.
The Plan is subject to annual re-approval by a majority of the Non-Interested
Plan Directors and is terminable at any time with respect to the Fund by a vote
of a majority of such Directors or by vote of the holders of a majority of the
shares of the Fund. Any agreement entered into pursuant to the Plan with a
Service Organization is terminable with respect to the Fund without penalty, at
any time, by vote of a majority of the Non-Interested Plan Directors, by vote
of the holders of a majority of the shares of the Fund, by the Distributor or
by the Service Organization. Each agreement will also terminate automatically
in the event of its assignment.
The Company understands that Bank of America and/or some Service
Organizations may charge their clients a direct fee for administrative and
shareholder services in connection with the holding of Fund shares. These fees
would be in addition to any amounts which might be received under the Plans.
Small, inactive long-term accounts involving such additional charges may not be
in the best interest of shareholders.
The following table shows all sales loads, commissions and other
compensation received by the Distributor directly or indirectly from the Fund
during the most recent fiscal year ended February 28, 1995:
<TABLE>
<CAPTION>
Brokerage
Commis-
Net Under- sions in
writing Dis- Compensation connection
counts and on Redemption with Fund Other
Commissions and Repurchase Transactions Compensation(1)
----------- -------------- ------------ ---------------
<S> <C> <C> <C> <C>
Concord Financial
Group, Inc.
National Municipal
Bond Fund $9,400 $ 0 $ 0 $ 0
</TABLE>
- ---------------
(1) Represents the total of (i) amounts paid to the Administrator for
administrative services provided to the Fund (see
"Management-Administrator" above) and (ii) payments made under the
Shareholder Service Plan (see discussion above).
YIELD, TAX-EQUIVALENT YIELD AND TOTAL RETURN
From time to time, the yield, tax-equivalent yield and the total return
of the Fund may be quoted in and compared to
-41-
<PAGE> 350
other mutual funds with similar investment objectives in advertisements,
shareholder reports or other communications to shareholders. The Fund may also
include calculations in such communications that describe hypothetical
investment results. (Such performance examples will be based on an express set
of assumptions and are not indicative of the performance of the Fund.) Such
calculations may from time to time include discussions or illustrations of the
effects of compounding in advertisements. "Compounding" refers to the fact
that, if dividends or other distributions on a Fund investment are reinvested
by being paid in additional Fund shares, any future income or capital
appreciation of the Fund would increase the value, not only of the original
Fund investment, but also of the additional Fund shares received through
reinvestment. As a result, the value of the Fund investment would increase
more quickly than if dividends or other distributions had been paid in cash.
The Fund may also include discussions or illustrations of the potential
investment goals of a prospective investor (including but not limited to tax
and/or retirement planning), investment management techniques, policies or
investment suitability of the Fund, economic conditions, legislative
developments (including pending legislation), the effects of inflation and
historical performance of various asset classes, including but not limited to
stocks, bonds and Treasury bills. From time to time advertisements or
communications to shareholders may summarize the substance of information
contained in shareholder reports (including the investment composition of the
Fund and a Portfolio), as well as the views of the Portfolio's investment
adviser as to current market, economic, trade and interest rate trends,
legislative, regulatory and monetary developments, investment strategies and
related matters believed to be of relevance to the Fund. The Fund may also
include in advertisements charts, graphs or drawings which illustrate the
potential risks and rewards of investment in various investment vehicles,
including but not limited to stocks, bonds, Treasury bills and shares of the
Fund. In addition, advertisements or shareholder communications may include a
discussion of certain attributes or benefits to be derived by an investment in
the Fund and may include testimonials as to the investment adviser's
capabilites by clients. Such advertisements or communications may include
symbols, headlines or other material which highlight or summarize the
information discussed in more detail therein. With proper authorization, the
Fund may reprint articles (or excerpts) written regarding the Fund and provide
them to prospective shareholders. Performance information with respect to the
Fund is generally available by calling (800) 346-2087.
Yield Calculations. The yield of the Fund is calculated by dividing
the net investment income per share (as described below) earned by the Fund
during a 30-day (or one month) period by the maximum offering price per share on
the last
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day of the period and annualizing the result on a semi-annual basis by adding
one to the quotient, raising the sum to the power of six, subtracting one from
the result and then doubling the difference. The Fund's net investment income
per share earned during the period is based on the average daily number of
shares outstanding during the period entitled to receive dividends and includes
dividends and interest earned during the period minus expenses accrued for the
period, net of reimbursements. This calculation can be expressed as follows:
a-b
Yield = 2 [(----- + 1)(6) - 1]
cd
Where: a = dividends and interest earned during the period.
b = expenses accrued for the period (net of
reimbursements).
c = the average daily number of shares outstanding
during the period that were entitled to receive
dividends.
d = maximum offering price per share on the last day
of the period.
For the purpose of determining net investment income earned during the
period (variable "a" in the formula), except as noted below, interest earned on
debt obligations is calculated by computing the yield to maturity of each
obligation based on the market value of the obligation (including actual accrued
interest) at the close of business on the last business day of each month, or,
with respect to obligations purchased during the month, the purchase price (plus
actual accrued interest), and dividing the result by 360 and multiplying the
quotient by the market value of the obligation (including actual accrued
interest) in order to determine the interest income on the obligation for each
day of the subsequent month that the obligation is held. For purposes of this
calculation, it is assumed that each month contains 30 days. The maturity of an
obligation with a call provision is the next call date on which the obligation
reasonably may be expected to be called or, if none, the maturity date. With
respect to debt obligations purchased at a discount or premium, the formula
generally calls for amortization of the discount or premium. The amortization
schedule will be adjusted monthly to reflect changes in the market values of
such debt obligations.
Interest earned on tax-exempt obligations that are issued without
original issue discount and have a current market discount is calculated by
using the coupon rate of interest
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instead of the yield to maturity. In the case of tax-exempt obligations that
are issued with original issue discount but which have discounts based on
current market value that exceed the then-remaining portion of the original
issue discount (market discount), the yield to maturity is the imputed rate
based on the original issue discount calculation. On the other hand, in the
case of tax- exempt obligations that are issued with original issue discount
but which have the discounts based on current market value that are less than
the then-remaining portion of the original issue discount (market premium), the
yield to maturity is based on the market value.
With respect to mortgage or other receivables-backed obligations which
are expected to be subject to monthly payments of principal and interest ("pay
downs"), (a) gain or loss attributable to actual monthly pay downs are accounted
for as an increase or decrease to interest income during the period; and (b) the
Portfolio may elect either (i) to amortize the discount and premium on the
remaining security, based on the cost of the security, to the weighted average
maturity date, if such information is available, or to the remaining term of the
security, if any, if the weighted average maturity date is not available, or
(ii) not to amortize discount or premium on the remaining security.
Undeclared earned income will be subtracted from the maximum offering
price per share (variable "d" in the formula). Undeclared earned income is the
net investment income which, at the end of the base period, has not been
declared as a dividend, but is reasonably expected to be and is declared and
paid as a dividend shortly thereafter. The Fund's maximum offering price per
share for purposes of the formula includes the maximum sales load imposed by the
Fund -- currently 4.50% of the per share offering price.
The Fund's "tax-equivalent" yield is computed by dividing that portion
of the Fund's yield (calculated as above) that is tax exempt by one minus a
stated income tax rate and adding the product to that portion, if any, of the
Fund's computed yield that is not tax exempt. Tax-equivalent yields assume the
payment of Federal income taxes at the stated rate.
Based on the foregoing calculations, the Fund's yield and tax-
equivalent yield (after fee waivers and reimbursements) for the 30 day period
ended February 28, 1995 were 5.46% and 7.91%, respectively.
Total Return Calculations. The Fund may compute its average annual
total return by determining the average annual compounded rates of return during
specified periods that equate the initial amount invested to the ending
redeemable value of such investment. This is done by dividing the ending
redeemable
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value of a hypothetical $1,000 initial payment by $1,000 and raising the
quotient to a power equal to one divided by the number of years (or fractional
portion thereof) covered by the computation and subtracting one from the
result. This calculation can be expressed as follows:
ERV (1/n)
T = [(-----) - 1]
P
Where: T = average annual total return.
ERV = ending redeemable value at the end
of the period covered by the
computation of a hypothetical $1,000
payment made at the beginning of the
period.
P = hypothetical initial payment of $1,000.
n = period covered by the computation,
expressed in terms of years.
The Fund computes its aggregate total return by determining the
aggregate rate of return during specified periods that likewise equates the
initial amount invested to the ending redeemable value of such investment. The
formula for calculating aggregate total return is as follows:
ERV
-----
aggregate total return = [( P - 1)]
The calculations of average annual total return and aggregate total
return assume the reinvestment of all dividends and capital gain distributions
on the reinvestment dates during the period. The ending redeemable value
(variable "ERV" in each formula) is determined by assuming complete redemption
of the hypothetical investment and the deduction of all nonrecurring charges at
the end of the period covered by the computations. In addition, the Fund's
average annual total return and aggregate total return quotations reflect the
deduction of the maximum sales load charged in connection with the purchase of
Fund shares.
Based on the foregoing calculations, the average annual total return
(after fee waivers and reimbursements) for the Fund for the one year period
ended February 28, 1995 and for the period January 28, 1994 (commencement of
operations) through February 28, 1995 were (1.84)% and (2.62)%, respectively.
Based on the foregoing calculations, the aggregate annual total return (after
fee waivers and reimbursements) for the Fund for the one
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year period ended February 28, 1995 and for the period January 28, 1994
(commencement of operations) through February 28, 1995 were (1.84)% and
(2.82)%, respectively
The Fund may advertise total return data without reflecting the sales
load imposed on the purchase of shares of the Fund in accordance with the rules
of the Securities and Exchange Commission. Quotations which do not reflect the
sales load will, of course, be higher than quotations which do.
GENERAL INFORMATION
DESCRIPTION OF SHARES
The Company is an open-end management investment company organized as
a Maryland corporation on October 27, 1982. The Fund's Charter authorizes the
Board of Directors to issue up to two hundred billion full and fractional common
shares. Pursuant to the authority granted in the Charter, the Board of
Directors has authorized the issuance of twenty-two classes of stock - Classes A
through W Common Stock, $.001 par value per share, representing interests in
twenty-two separate investment portfolios. Class Q represents interests in the
National Municipal Bond Fund. The Company's charter also authorizes the Board
of Directors to classify or reclassify any particular class of the Company's
shares into one or more series.
Shares have no preemptive rights and only such conversion or exchange
rights as the Board may grant in its discretion. When issued for payment as
described in the Prospectus, the Company's shares will be fully paid and
non-assessable. For information concerning possible restrictions upon the
transferability of the Company's shares and redemption provisions with respect
to such shares, see "Additional Purchase and Redemption Information."
Shareholders are entitled to one vote for each full share held, and
fractional votes for fractional shares held, and will vote in the aggregate and
not by class or series except as otherwise required by the 1940 Act or other
applicable law or when permitted by the Board of Directors. Shares have
cumulative voting rights to the extent they may be required by applicable law.
Rule 18f-2 under the 1940 Act provides that any matter required to be
submitted to the holders of the outstanding voting securities of an investment
company such as the Company shall not be deemed to have been effectively acted
upon unless approved by a majority of the outstanding shares of each fund
affected by the matter. The Fund is affected by a matter unless it is clear
that the interests of each of the Company's funds in the matter are
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<PAGE> 355
substantially identical or that the matter does not affect any interest of the
Fund. Under Rule 18f-2 any change in a fundamental investment policy would be
effectively acted upon with respect to the Fund only if approved by a majority
of the outstanding shares of the Fund. However, the rule also provides that
the ratification of independent public accountants, the approval of principal
underwriting contracts and the election of directors may be effectively acted
upon by shareholders of the Company voting without regard to particular funds.
Notwithstanding any provision of Maryland law requiring a greater vote
of the Company's common stock (or of the shares of the Fund voting separately as
a class) in connection with any corporate action, unless otherwise provided by
law (for example, by Rule 18f-2 discussed above) or by the Company's Charter,
the Company may take or authorize such action upon the favorable vote of the
holders of more than 50% of the outstanding common stock of the Company voting
without regard to class.
THE PORTFOLIO
The Portfolio is a separate series of Master Investment Trust, Series
II, which was organized October 26, 1992 as a Delaware business trust. The
Master Trust's Declaration of Trust authorizes its Board of Trustees to issue an
unlimited number of interests of beneficial interest and to establish and
designate any unissued interests of one or more additional series of interests.
Investors in the Portfolio are entitled to distributions arising from the net
investment income and net realized gains, if any, earned on investments held by
the Portfolio. Investors are also entitled to participate in the net
distributable assets of the Portfolio on liquidation. Beneficial interests have
no preemptive, conversion or exchange rights.
REPORTS
Shareholders will receive unaudited semi-annual reports describing the
Portfolio's and the Fund's investment operations and annual financial statements
of the Portfolio and the Fund, audited by the independent accountants.
CUSTODIAN, ACCOUNTING AGENT AND TRANSFER AGENT
PNC Bank, National Association ("PNC") has been appointed custodian for
the Fund and the Portfolio. PFPC Inc., ("PFPC") 103 Bellevue Parkway,
Wilmington, DE 19809, provides the Fund and Portfolio with certain accounting
services pursuant to separate fund accounting services agreements with the
Administrator. Under the fund accounting services agreements, PFPC has agreed
to provide certain accounting, bookkeeping, pricing, dividend and distribution
calculation services with respect to the Company and the Portfolio,
respectively. The
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<PAGE> 356
monthly fees charged by PFPC under the fund accounting services agreements are
borne by the Fund and the Portfolio, respectively. As custodian of the assets
of the Fund and the Portfolio, PNC (i) maintains a separate account or accounts
in the name of the Fund and Portfolio (as applicable), (ii) holds and disburses
portfolio securities; (iii) makes receipts and disbursements of money, (iv)
collects and receives income and other payments and distributions on account of
portfolio securities, (v) responds to correspondence from security brokers and
others relating to its respective duties and (vi) makes periodic reports
concerning its respective duties.
BISYS Fund Services Ohio, Inc., 3435 Stelzer Road, Columbus, Ohio
43219-3035 serves as transfer and dividend disbursing agent for the Fund.
COUNSEL
Drinker Biddle & Reath (of which W. Bruce McConnel, III, Secretary of
the Company, is a partner), 1345 Chestnut Street, Suite 1100, Philadelphia,
Pennsylvania 19107, serves as counsel to the Company and the Master Trust and
will pass upon the legality of the shares offered hereby.
INDEPENDENT ACCOUNTANTS
Price Waterhouse LLP, with offices at 1177 Avenue of the Americas, New
York, New York 10036, has been selected as independent accountants of the Fund
and for the Portfolio.
SHAREHOLDER VOTE
As used in the Prospectus and this Statement of Additional Information,
a "vote of a majority" of the outstanding interests of the Portfolio, the
outstanding shares of the Fund or a particular series means the affirmative vote
of the lesser of (a) more than 50% of the outstanding interests of the
Portfolio, the outstanding shares of the Fund or such series, or (b) 67% of the
interests of the Portfolio, the shares of the Fund or such series present at a
meeting at which more than 50% of the outstanding interests of the Portfolio,
the outstanding shares of the Fund or series (as applicable) are represented in
person or by proxy.
At June 15, 1995, the name, address and share ownership of the entities
which held of record more than 5% of the outstanding Pacific Horizon Shares of
the Treasury Fund were as follows: BA Investment Services Inc., For the Benefit
of Clients, 555 California Street, 4th Floor, Department #4337, San Francisco,
CA 94104, 98,230,626.530 shares (7.70%); Bank of America State Trust Co., 299 N.
Euclid Avenue, Pasadena, CA 91101, 1,044,975,154.790 shares (82.00%); and
Hellman & Freidman
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<PAGE> 357
Capital Partners II, Limited Partnership, Attention: Georgia Lee, 1 Maritime
Plaza, 12th Floor, San Francisco, CA 94111, 1,216,118,073.700 shares (095.42%).
At June 16, 1995, the name, address and share ownership of the entities
which held of record more than 5% of the outstanding Horizon Shares of the
Treasury Fund was as follows: Bank of America Trustee/Custodian for Investing
in Horizon Treasury, Attn: Eric Peterson, 701 S. Western Avenue, 2nd Floor,
Glendale, CA 91201, 398,540,438.170 shares (68.901%); Security Pacific State
Trust Co., Agreement for Sec. PACWA Participants, Attn: Cash Sweep Funds (L.
Goekjian), P.O. Box 91630, Pasadena, CA 91101, 94,279,024.120 shares (16.299%).
At June 16, 1995, the name, address and share ownership of the entities
which held beneficially more than 5% of the outstanding Horizon Service Shares
of the Treasury Fund were as follows: Bank of America FM&TS Operat CA, Attn:
CTF Unit, 701 South Western Avenue, Glendale, CA 91201, 65,745,555.320 shares
(23.658%); Bank of America Nevada Southern Comm. Bank, Attn: Dan Dykes, P.O. Box
98600, Las Vegas, NV 89193, 63,974,589.270 shares (23.020%). Security Pacific
State Trust Co., Agreement for Sec. PACWA Participants, Attn: Cash Sweep Funds,
P.O. Box 91630, Pasadena, CA 91101, 56,906,301.540 shares (20.477%); and
Security Pacific Cash Management, c/o Bank of America - GPO M/C 5533, Attn:
Liezel Barangan, 1850 Gateway Boulevard, Concord, CA 94520, 77,003,300 shares
(27.709%). At June 15, 1995, the name, address and, share ownership of the
entity which held of record more than 5% of the outstanding Horizon Service
Shares of the Treasury Fund was as follows: Omnibus A/C for the Shareholder
Accounts maintained by Concord Financial Services, Inc., Attn: Linda Zerbe,
First and Market Building, 100 First Avenue, Suite 300, Pittsburgh, PA 15222,
263,629,755.130 shares (65.51%). At June 15, 1995 the name, address and share
ownership of the entities which held of record more than 5% of the outstanding
Pacific Horizon Shares of the Prime Fund were as follows: BA Investment
Services Inc., For the Benefit of Clients, 555 California Street, 4th Floor,
Department #4337, San Francisco, CA 94104, 514,119,226.900 shares (38.76%); Bank
of America State Trust Co., 299 N. Euclid Avenue, Pasadena, CA 91101,
392,983,248.780 shares (29.63%); and Southwest Securities Inc., Attn:
Cashiering, 201 Elm Street, Suite 4300, Dallas, TX 75270, 169,018,910.270 shares
(12.74%). At June 16, 1995, the name, address and share ownership of the
entities which held of record more than 5% of the outstanding Horizon Shares of
the Prime Fund were as follows: Bank of America Trustee/Custodian for Investing
Horizon Prime, Attn: Eric Peterson, 701 S. Western Avenue, 2nd Floor, Glendale,
CA 91201, 385,058,852.030 shares (56.838%); and Bank of America NT&SA, Attn: Kay
Warren/Dept. #5596, 1455 Market Street, San Francisco, CA 94103, 57,300,000.00
shares (9.934%). At June 15, 1995, the name, address and share ownership of the
entity which held of record more than 5% of the outstanding Horizon Service
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<PAGE> 358
Shares of the Prime Fund were as follows: Omnibus A/C for the Shareholder
Accounts maintained by Concord Financial Services, Inc., Attn: Linda Zerbe,
First and Market Building, 100 First Avenue, Suite 300, Pittsburgh, PA 15222,
752,776,315.610 shares (70.26%).
At June 16, 1995, the name, address and share ownership of the entities
which held beneficially more than 5% of the outstanding Horizon Service Shares
of the Prime Fund were as follows: Bank of America NT&SA Financial Management
and Trust Services, 701 S. Western Avenue, Glendale, CA 91201, 74,038,082.090
shares (9.835%); Capital Network Services, Attn: Donna Novell, One Bush Street,
11th Floor, San Francisco, CA 94104, 86,407,261.23 shares (11.478%); Security
Pacific Cash Management, c/o Bank of America. GPO. M/C 5533 Attn: Liezel
Barangan, 1850 Gateway Boulevard, M/C 5533, Concord, CA 94520, 379,755,600.000
shares (50.447%); Security Pacific State Trust Co., Agreement for SecPAC WA
Participants, Attn: Cash Sweep Funds (L. Goekjian) P.O. Box 91630, Pasadena, CA
91101, 54,321,621.330 shares (7.216%); and Southwest Securities Inc., Attn: Mary
Lisenber, 1201 Elm Street, Suite 4300, Dallas, TX 75270, 130,146,660.030 shares
(17.289%).
At June 15, 1995, the name, address and share ownership of the entities
which held of record more than 5% of the outstanding Pacific Horizon Shares of
the Tax-Exempt Money Fund were as follows: BA Investment Services, Inc., For
the Benefit of Clients, 555 California Street, 4th Floor, Department #4337, San
Francisco, CA 94104, 12,233,845.190 shares (39.73%); Southwest Securities Inc.,
Attn: Cashiering, 1201 Elm Street, Suite 4300, Dallas, TX, 75270, 10,387,253.930
shares (33.73%); and Bank of America State Trust Co., 299 N. Euclid Avenue,
Pasadena, CA 91101, 6,515,635.730 shares (21.16%).
At June 16, 1995, the name, address and share ownership of the
entities which held of record more than 5% of the outstanding Horizon Shares of
the Tax-Exempt Money Fund were as follows: Bank of America Custodian For
Investing in Horizon Tax-Exempt Money Fund, Attn: Eric Peterson, 701 S. Western
Avenue, 2nd Floor, Glendale, CA 19201, 129,582,555.65 shares (38.576%);
Continental Bank National Association Custodian for the Benefit of Custodian Co.
Attn: Mary Chester, 231 South LaSalle Street, 6Q, Chicago, IL 60697,
152,699,416.270 shares (45.458%); and Maine Midland Bank NA, Investment
Services, 17th Floor, Attn: Christine Mincel, One Marine Midland Center,
Buffalo, NY 14203, 21,684,672.980 shares (6.455%).
At June 15, 1995, the name, address and share ownership of the entities
which held of record more than 5% of the outstanding shares of the Horizon
Service Shares of the Tax-Exempt Money Fund were as follows: Furman C. Moseley
and Susan R. Moseley Tenn. In Common, 1201 3rd Avenue, Box 7C, Seattle, WA
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98101, 4,165,513.060 shares (9.91%); Omnibus A/C for the shareholder accounts
maintained by Concord Financial Services Inc., Attn: Linda Zerbe, First and
Market Building, 100 First Avenue, Suite 300, Pittsburgh, PA 15222,
22,398,544.590 shares (53.31%); and Omnibus A/C for the Shareholder Accounts
maintained by Concord Financial Services Inc. Attn: First and Market Building,
100 First Avenue, Suite 300, Pittsburgh, PA 15222, 3,494,305.180 shares
(8.31%). At June 16, 1995, the name, address and share ownership of the
entities which held beneficially more than 5% of the outstanding Horizon
Service Shares of the Tax-Exempt Money Fund were as follows: BA Investment
Services Inc., 555 California Street, 4th Floor Dept. #4337, San Francisco, CA
94104, 1,362,028.590 shares (5.260%); Bank of America FM&TS Oper. CA, Attn: CTF
Unit, 701 South Western Avenue, Glendale, CA 91201, 2,293,907.40 shares
(8.859%); and Southwest Securities, Inc., Attn: Mary Lisenber, 1201 Elm Street,
Suite 430, Dallas, TX 75270, 21,021,580.530 shares (81.187%). At June 15,
1955, the name, address and share ownership of the entities which held of
record more than 5% of the outstanding Pacific Horizon Shares of the Government
Fund were as follows: Bank of America, NT&SA, The Private Bank, Attn: ACI Unit
#8329, 701 S. Western Avenue, Glendale, CA 91201, 79,875,532.090 shares
(22.71%); Bank of America State Trust Co., 299 N. Euclid Avenue., Pasadena, CA
91101, 64,756,966.280 shares (18.41%); and BA Investment Services Inc., For the
Benefit of Clients, 555 California Street, 4th Floor, Department #4337, San
Francisco, CA 94104, 170,940,404.650 shares (48.60%). At June 16, 1995, the
name, address and share ownership of the entities which held of record more
than 5% of the outstanding Horizon Shares of the Government Fund were as
follows: Bank of America NT&SA Trustee/Custodian for Investing in Horizon
Shares of the Government Fund, Attn: Cynthia Beauvais, 701 South Western
Avenue., Glendale, CA 91201, 9,327,446.350 shares (5.028%); Bank of America
State Trust, Attn: Rigo Barrett, 299 N. Euclid Avenue, Pasadena, CA 91101,
28,063,486.740 shares (15.129%); Capital Network Services, Attn: Donna Novell,
One Bush Street, 11th Floor, San Francisco, CA 94104, 24,227,801.980 shares
(13.061%); County of Orange, Matt Raabe, P.O. Box 4515, Santa Ana, CA 92702,
10,000,000.000 shares (5.391%); Cypress Insurance Co., Attn: Larry Tetzloff,
9290 W. Dodge Road, Omaha, NE 68124, 9,996,515.930 shares (5.389%); Harr & Co.,
c/o Bank of New York, Attn: Bimal Sana, Spec. Prec. Dept., One Wall Street, 5th
Floor, New York, NY 10286, 14,000,000.000 shares (7.547%); Micron Electronics
Inc., Attn: Debbie Meigand, 900 East Karcher Road, Nanpa, ID 83687,
16,080,510.14 shares (8.669%); and Silocin Magic Corp., Attn: Meng A. Lim,
20300 Stevens Creek Boulevard., Suite 400, Cupertino, CA 95014, 18,058,262.110
shares (9.735%). At June 15, 1995, the name, address and share ownership of
the entities which held of record more than 5% of the outstanding Horizon
Service Shares of the Government Fund were as follows: Spacelabs Medical, Inc.,
Attn: Scott Bender, P.O. Box 97013, Redmond, WA 98073, 14,572,000.000 shares
(5.70%); Good Health
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Plan of WA, Attn: Tsai Cheng, 1501 9th Avenue, Suite 500, Seattle, WA 98101,
16,584,866.580 shares (6.49%); Omnibus A/C for the Shareholder Accounts
maintained by Concord. Financial Services Inc., Attn: Linda Zerbe, First and
Market Building, 100 First Avenue, Suite 300, Pittsburgh, PA 15222,
68,555,257.020 shares (26.85%). At June 16, 1995, the name, address and share
ownership of the entities which held beneficially more than 5% of the Horizon
Service Shares of the Government Fund were as follows: Bank of America Nevada
Southern Comm. Bank, Attn: Dan Dykes, P.O. Box 98600, Las Vegas, NV 89193-8600,
35,849,966.050 shares (52.294%); and Capital Network Services, Attn: Donna M.
Howell, One Bush Street, 11th Floor, San Francisco, CA 94104-4425,
23,929,840.440 shares (34.906%). At June 15, 1995, the name, address and share
ownership of the entities which held of record more than 5% of the Pacific
Horizon Shares of the Treasury Only Fund were as follows: Bank of America
NT&SA, the Private Bank, Attn: ACI Unit 48329, 701 South Western Avenue,
Glendale, CA 91201, 48,516,900.490 shares (31.68%) Bank of America State Trust
Co., 299 N. Euclid Avenue, Pasadena, CA 91101, 22,350,831.320 shares (14.59%);
and BA Investment Services Inc., For the Benefit of Clients, 555 California
Street, 4th Floor, Department #4337, San Francisco, CA 94104, 69,016,521.500
shares (45.06%). At June 15, 1995, the name, address and share ownership of
the entities which held of record more than 5% of the outstanding Horizon
Service Shares of the Treasury Only Fund were as follows: National Home
Mortgage Corp., Attn: Mortgage Banking Treasury Operations, 5565 Morehouse
Drive, 3rd Floor, San Diego, CA 92121, 12,147.667,580 shares (9.42%); Comcare,
Inc., 4001 N. 3rd Street, Suite 120, Phoenix, AZ 85012, 26,230,243.620 shares
(20.34%); and Omnibus A/C For the Shareholder Accounts Maintained by Concord
Financial Services Inc., Attn: Linda Zerbe, First and Market Building, 100
First Avenue, Suite 300, Pittsburgh, PA 15222, 21,883,084.450 shares (16.97%).
At June 16, 1995, the name, address and share ownership of the entities which
held beneficially more than 5% of the outstanding Horizon Service Shares of the
Treasury Only Fund were as follows: BA Investment Service Inc., 555 California
Street, 4th Floor Dept. #4337, San Francisco, CA 94104, 6,403,628.120 shares
(28.679%); Bank of America NT&SA Trustee/Custodian for Investing in Horizon
Service Shares of the Treasury Only Fund, Attn: Cynthia Beauvais, 701 South
Western Avenue, Glendale, CA 91201, 3,501,414.020 shares (15.681%); Bank of
America State Trust, Attn: Rigo Barrett, 299 N. Euclid Avenue, Pasadena, CA
91101, 5,420,893.150 shares (24.277%); Fair Isaac & Co., Attn: Christine Tam,
120 North Redwood, San Rapheal, CA 94903-1996, 1,338,800.750 shares (5.996%);
Foothill/Eastern Transportation Corridor Agency, Attn: Laura Barker, 201 East
Sandpot, Suite 200, Santa Anna, CA 92707, 2,559,586.380 shares (11.463%); and
Nexus, Attn: Kathleen Menace, P.O. Box 60637, Sunnyvale, CA 94088-0637,
2,525,153.380 shares (11.309%). At June 15, 1995, the name, address and share
ownership of the entities which held of record more than 5% of the outstanding
Pacific Horizon Shares of the Prime Value Fund
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were as follows: BA Investment Services Inc., For the Benefit of Clients, 555
California Street, 4th Floor, Department #4337, San Francisco, CA 94104,
16,383,467.170 shares (26.45%); and Bank of America State Trust Co., Attn: Leon
Goekjian, P.O. Box 91630, Pasadena, CA 91101, 45,078,465.290 shares (72.79%). At
June 16, 1995, the name, address and share ownership of the entity which held of
record more than 5% of the outstanding Horizon Shares of the Prime Value Fund
was as follows: Tice & Co., c/o M&T, Attn: Cash Management Clerk, 8th Floor,
P.O. Box 1377, Buffalo, NY 14240, 453,078,561.590 shares (93.510%). At June 15,
1995, the name, address and share ownership of the entity which held of record
more than 5% of the outstanding shares of the Pacific Horizon Shares of the
California Tax-Exempt Money Market Fund was as follows: BA Investment Services
Inc., For the Benefit of Clients, 555 California Street, 4th Floor, Department
#4337, San Francisco, CA 94104, 204,443,886.590 shares (22.07%). At June 15,
1995, the name, address and share ownership of the entities which held of record
more than 5% of the outstanding shares of the Horizon Service Shares of the
California Tax-Exempt Money Market Fund were as follows: Leo Zuckerman Trust,
DTD 12-11-91,4444 Viewridge Avenue, San Diego, CA 92123, 4,850,877.280 shares
(5.35%); and Omnibus A/C for the Shareholder Accounts Maintained by Concord
Financial Services Inc. Attn: Linda Zerbe, First and Market Building, 100 First
Avenue, Suite 300, Pittsburgh, PA 15222, 13,391,453.970 shares (14.77%). At
June 16, 1995, the name, address and share ownership of the entity which held
beneficially more than 5% of the outstanding shares of the Horizon Service
Shares of the California Tax-Exempt Money Market Fund was as follows: BA
Investment Services Inc., 555 California Street, 4th Floor, Dept. #4337, San
Francisco, CA 94109, 13,792,509.310 shares (99.206%). At June 15, 1995, the
name, address and shares ownership of the entities which held of record more
than 5% of the outstanding shares of the Flexible Bond Fund were as follows:
Peter F. Smith and Jacquelyn L. Smith, JTWROS, 1785 C. Blodgett Road, Mount
Vernon, WA 98273, 13,973.917 shares (5.58%); and BA Investment Services, Inc.,
FBO 200724011, 185 Berry Street, 3rd Floor #2640, San Francisco, CA 94104,
22,436.531 shares (8.96%). At June 15, 1995 the name, address and share
ownership of the entity which held of record more than 5% of the outstanding
shares of the Asset Allocation Fund was as follows: Bank of America, Texas
AATTEE. National-O'Neill Supplemental Savings Plan, Attn: Mutual Funds
(81-6-01005-0), P.O. Box 94627, Pasadena, CA 91109, 24,289,973 shares (5.07%).
At June 15, 1995 the name, address and share ownership of the entities which
held of record more than 5% of the outstanding shares of the National Municipal
Bond Fund were as follows: BA Investment Services, Inc. FBO 405084421, 555
California Street, 4th Floor, #2640, San Francisco, CA 94104, 26,336.154 shares
(8.31%); and BA Investment Services, Inc., FBO 405266591, 555 California Street,
4th Floor, #2640, San Francisco, CA 94104, 25,034.024 shares (7.90%). At June
15, 1995 the name, address and share ownership of the entities which held
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of record more than 5% of the outstanding shares of the Corporate Bond Fund were
as follows: Dean Witter Reynolds Inc., 5 World Trade Center, 4th Floor, Attn:
5th O Div., New York, NY 10048, 138,820.000 shares (6.93%); and Smith Barney
Shearson, Inc., 333 W. 39th Street, 8th Floor, New York, NY 10001, 148,925.482
shares (7.43%).
At such date, no other person was known by the Company to hold of
record or beneficially more than 5% of the outstanding shares of any other
investment portfolio of the Company.
The Prospectus relating to the Fund and this Statement of Additional
Information omit certain information contained in the Company's registration
statement filed with the Securities and Exchange Commission. Copies of the
registration statement, including items omitted herein, may be obtained from the
Commission by paying the charges prescribed under its rules and regulations.
FINANCIAL STATEMENTS AND EXPERTS
The Annual Report for the Fund and the Portfolio for the fiscal year
ended February 28, 1995 accompanies this Statement of Additional Information.
The financial statements and notes thereto in that Annual Report are
incorporated in this Statement of Additional Information by reference, and have
been audited by Price Waterhouse LLP, whose report thereon also appears in such
Annual Report and is also incorporated herein by reference. Such financial
statements have been incorporated herein in reliance on the report of Price
Waterhouse LLP, independent accountants, given on the authority of said firm as
experts in auditing and accounting.
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<PAGE> 363
APPENDIX A
COMMERCIAL PAPER RATINGS
A Standard & Poor's commercial paper rating is a current assessment of
the likelihood of timely payment of debt considered short-term in the relevant
market. The following summarizes the rating categories used by Standard and
Poor's for commercial paper:
"A-1" - Issue's degree of safety regarding timely payment is strong.
Those issues determined to possess extremely strong safety characteristics are
denoted "A-1+."
"A-2" - Issue's capacity for timely payment is satisfactory. However,
the relative degree of safety is not as high as for issues designated "A-1."
"A-3" - Issue has an adequate capacity for timely payment. It is,
however, somewhat more vulnerable to the adverse effects of changes and
circumstances than an obligation carrying a higher designation.
"B" - Issue has only a speculative capacity for timely payment.
"C" - Issue has a doubtful capacity for payment.
"D" - Issue is in payment default.
Moody's commercial paper ratings are opinions of the ability of issuers
to repay punctually promissory obligations not having an original maturity in
excess of 9 months. The following summarizes the rating categories used by
Moody's for commercial paper:
"Prime-1" - Issuer or related supporting institutions are considered to
have a superior capacity for repayment of short-term promissory obligations.
Prime-1 repayment capacity will normally 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.
"Prime-2" - Issuer or related supporting institutions are considered to
have a strong capacity for repayment of short-
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term promissory 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 alternative liquidity is maintained.
"Prime-3" - Issuer or related supporting institutions have an
acceptable capacity for repayment of short-term promissory obligations. The
effects of industry characteristics and market composition may be more
pronounced. Variability in earnings and profitability may result in changes in
the level of debt protection measurements and the requirement for relatively
high financial leverage. Adequate alternate liquidity is maintained.
"Not Prime" - Issuer does not fall within any of the Prime rating
categories.
The three rating categories of Duff & Phelps for investment grade
commercial paper and short-term debt are "D-1," "D-2" and "D-3." Duff & Phelps
employs three designations, "D-1+," "D-1" and "D-1-," within the highest rating
category. The following summarizes the rating categories used by Duff & Phelps
for commercial paper:
"D-1+" - Debt possesses 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 issue as investment grade. Risk factors are larger and subject
to more variation. Nevertheless, timely payment is expected.
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"D-4" - Debt possesses speculative investment characteristics.
Liquidity is not sufficient to ensure 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 short-term ratings apply to debt obligations that are payable on
demand or have original maturities of up to three years. The following
summarizes the rating categories used by Fitch for short-term obligations:
"F-1+" - Securities possess exceptionally strong credit quality.
Issues assigned this rating are regarded as having the strongest degree of
assurance for timely payment.
"F-1" - Securities possess very strong credit quality. Issues assigned
this rating reflect an assurance of timely payment only slightly less in degree
than issues rated "F-1+."
"F-2" - Securities possess good credit quality. Issues assigned this
rating have a satisfactory degree of assurance for timely payment, but the
margin of safety is not as great as the "F-1+" and "F-1" categories.
"F-3" - Securities possess fair credit quality. Issues assigned this
rating have characteristics suggesting that the degree of assurance for timely
payment is adequate; however, near-term adverse changes could cause these
securities to be rated below investment grade.
"F-S" - Securities possess weak credit quality. Issues assigned this
rating have characteristics suggesting a minimal degree of assurance for timely
payment and are vulnerable to near-term adverse changes in financial and
economic conditions.
"D" - Securities are in actual or imminent payment default.
Fitch may also use the symbol "LOC" with its short-term ratings to
indicate that the rating is based upon a letter of credit issued by a commercial
bank.
Thomson BankWatch short-term ratings assess the likelihood of an
untimely or incomplete payment of principal or interest of unsubordinated
instruments having a maturity of one year or less which is issued by United
States commercial banks, thrifts and non-bank banks; non-United States banks;
and broker-
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dealers. The following summarizes the ratings used by Thomson BankWatch:
"TBW-1" - This designation represents Thomson BankWatch's highest
rating category and indicates a very high degree of likelihood that principal
and interest will be paid on a timely basis.
"TBW-2" - This designation indicates that while the degree of safety
regarding timely payment 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 the lowest investment grade
category and indicates that while the debt is more susceptible to adverse
developments (both internal and external) than obligations with higher ratings,
capacity to service principal and interest in a timely fashion is considered
adequate.
"TBW-4" - This designation indicates that the debt is regarded as non-
investment grade and therefore speculative.
IBCA assesses the investment quality of unsecured debt with an original
maturity of less than one year which is issued by bank holding companies and
their principal bank subsidiaries. The following summarizes the rating
categories used by IBCA for short-term debt ratings:
"A1" - Obligations are supported by the highest capacity for timely
repayment. Where issues possess a particularly strong credit feature, a rating
of A1+ is assigned.
"A2" - Obligations are supported by a good capacity for timely
repayment.
"A3" - Obligations are supported by a satisfactory capacity for timely
repayment.
"B" - Obligations for which there is an uncertainty as to the capacity
to ensure timely repayment.
"C" - Obligations for which there is a high risk of default or which
are currently in default.
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CORPORATE AND MUNICIPAL LONG-TERM DEBT RATINGS
The following summarizes the ratings used by Standard & Poor's for
corporate and municipal debt:
"AAA" - This designation represents the highest rating assigned by
Standard & Poor's to a debt obligation and indicates an extremely strong
capacity to pay interest and repay principal.
"AA" - Debt is considered to have a very strong capacity to pay
interest and repay principal and differs from AAA issues only in small degree.
"A" - Debt is considered to have a strong capacity to pay interest and
repay principal although such issues are somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than debt in
higher-rated categories.
"BBB" - Debt is regarded as having an adequate capacity to pay interest
and repay principal. Whereas such issues normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher-rated categories.
"BB," "B," "CCC," "CC" and "C" - Debt is regarded, on balance, as
predominantly speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligation. "BB" indicates the
lowest degree of speculation and "C" the highest degree of speculation. While
such debt will likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major risk exposures to adverse
conditions.
"BB" - Debt has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure
to adverse business, financial or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. The "BB"
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied "BBB-" rating.
"B" - Debt has a greater vulnerability to default but currently has the
capacity to meet interest payments and principal repayments. Adverse business,
financial or economic conditions will likely impair capacity or willingness to
pay interest and repay principal. The "B" rating category is also used for debt
subordinated to senior debt that is assigned an actual or implied "BB" or "BB-"
rating.
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"CCC" - Debt has a currently identifiable vulnerability to default, and
is dependent upon favorable business, financial and economic conditions to meet
timely payment of interest and repayment of principal. In the event of adverse
business, financial or economic conditions, it is not likely to have the
capacity to pay interest and repay principal. The "CCC" rating category is also
used for debt subordinated to senior debt that is assigned an actual or implied
"B" or "B-" rating.
"CC" - This rating is typically applied to debt subordinated to senior
debt that is assigned an actual or implied "CCC" rating.
"C" - This rating is typically applied to debt subordinated to senior
debt which is assigned an actual or implied "CCC-" debt rating. The "C" rating
may be used to cover a situation where a bankruptcy petition has been filed, but
debt service payments are continued.
"CI" - This rating is reserved for income bonds on which no interest is
being paid.
"D" - Debt is in payment default. This rating is used when interest
payments or principal payments are not made on the date due, even if the
applicable grace period has not expired, unless S & P believes such payments
will be made during such grace period. "D" rating is also used upon the filing
of a bankruptcy petition if debt service payments 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 rating is attached to highlight derivative, hybrid, and
certain other obligations that S & P believes may experience high volatility or
high variability in expected returns due to non-credit risks. Examples of such
obligations are: securities whose principal or interest return is indexed to
equities, commodities, or currencies; certain swaps and options; and interest
only and principal only mortgage securities.
The following summarizes the ratings used by Moody's for corporate and
municipal long-term debt:
"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.
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"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 risks appear somewhat larger than in "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 considered medium-grade obligations, i.e., they are
neither highly protected nor poorly secured. Interest payments and principal
security appear adequate for the present but certain protective elements may be
lacking or may be characteristically unreliable over any 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 some speculative elements; "B" indicates a general lack of
characteristics of desirable investment; "Caa" represents a 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 (a) earnings of projects under construction, (b) earnings
of projects unseasoned in operation experience, (c) rentals which begin when
facilities are completed, or (d) payments to which some other limiting condition
attaches. Parenthetical rating denotes probable credit stature upon completion
of construction or elimination of basis of condition.
Moody's applies numerical modifiers 1, 2 and 3 in each generic
classification from "Aa" to "B" in its bond rating system. The modifier 1
indicates that the issuer ranks in the higher end of its generic rating
category; the modifier 2 indicates a mid-range ranking; and the modifier 3
indicates that the issuer ranks at the lower end of its generic rating category.
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The following summarizes the long-term debt ratings used by Duff &
Phelps 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 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 and greater in periods of 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 highest four ratings used by Fitch for
corporate and municipal bonds:
"AAA" - Bonds considered to be investment grade and of the highest
credit quality. The obligor has an exceptionally strong ability to pay interest
and repay principal, which is unlikely to be affected by reasonably foreseeable
events.
"AA" - Bonds considered to be investment grade and of very high credit
quality. The obligor's ability to pay interest and repay principal is very
strong, although not quite as strong as bonds rated "AAA." Because bonds rated
in the "AAA" and "AA" categories are not significantly vulnerable to foreseeable
future developments, short-term debt of these issuers is generally rated "F-1+."
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"A" - Bonds considered to be investment grade and of high credit
quality. The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse changes in
economic conditions and circumstances than bonds with higher ratings.
"BBB" - Bonds considered to be investment grade and of satisfactory
credit quality. The obligor's ability to pay interest and repay principal is
considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have an adverse impact on these
bonds, and therefore, impair timely payment. The likelihood that the ratings of
these bonds will fall below investment grade is higher than for bonds with
higher ratings.
"BB," "B," "CCC," "CC," "C," "DDD," "DD," and "D" - Bonds that possess
one of these ratings are considered by Fitch to be speculative investments. The
ratings "BB" to "C" represent Fitch's assessment of the likelihood of timely
payment of principal and interest in accordance with the terms of obligation for
bond issues not in default. For defaulted bonds, the rating "DDD" to "D" is an
assessment of the ultimate recovery value through reorganization or liquidation.
To provide more detailed indications of credit quality, the Fitch
ratings from and including "AA" to "C" may be modified by the addition of a plus
(+) or minus (-) sign to show relative standing within these major rating
categories.
IBCA assesses the investment quality of unsecured debt with an original
maturity of more than one year which is issued by bank holding companies and
their principal bank subsidiaries. The following summarizes the rating
categories used by IBCA for long-term debt ratings:
"AAA" - Obligations for which there is the lowest expectation of
investment risk. Capacity for timely repayment of principal and interest is
substantial such that adverse changes in business, economic or financial
conditions are unlikely to increase investment risk substantially.
"AA" - Obligations for which there is a very low expectation of
investment risk. Capacity for timely repayment of principal and interest is
substantial. Adverse changes in business, economic or financial conditions may
increase investment risk albeit not very significantly.
"A" - Obligations for which there is a low expectation of investment
risk. Capacity for timely repayment of principal and interest is strong,
although adverse changes in business,
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economic or financial conditions may lead to increased investment risk.
"BBB" - Obligations for which there is currently a low expectation of
investment risk. Capacity for timely repayment of principal and interest is
adequate, although adverse changes in business, economic or financial conditions
are more likely to lead to increased investment risk than for obligations in
higher categories.
"BB," "B," "CCC," "CC," and "C" - Obligations are assigned one of these
ratings where it is considered that speculative characteristics are present.
"BB" represents the lowest degree of speculation and indicates a possibility of
investment risk developing. "C" represents the highest degree of speculation
and indicates that the obligations are currently in default.
IBCA may append a rating of plus (+) or minus (-) to a rating to denote
relative status within major rating categories.
Thomson BankWatch 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 Thomson BankWatch for long-term debt ratings:
"AAA" - This designation represents the highest category assigned by
Thomson BankWatch to long-term debt and indicates that the ability to repay
principal and interest on a timely basis is very high.
"AA" - This designation indicates a superior ability to repay principal
and interest on a timely basis with limited incremental risk versus 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 Thomson BankWatch's lowest
investment grade category and indicates an acceptable capacity to repay
principal and interest. Issues rated "BBB" are, however, 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
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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.
"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 Standard and Poor'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 Standard & Poor's Ratings Group for municipal
notes:
"SP-1" - The issuers of these municipal notes exhibit very strong or
strong capacity to pay principal and interest. Those issues determined to
possess overwhelming safety characteristics are given a plus (+) designation.
"SP-2" - The issuers of these municipal notes exhibit satisfactory
capacity to pay principal and interest.
"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 Investors Service, Inc.
for short-term notes:
"MIG-1"/"VMIG-1" - Loans bearing this designation 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" - Loans bearing this designation are of high quality,
with margins of protection ample although not so large as in the preceding
group.
"MIG-3"/"VMIG-3" - Loans bearing this designation are of favorable
quality, with all security elements accounted for but lacking the undeniable
strength of the preceding grades.
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Liquidity and cash flow protection may be narrow and market access for
refinancing is likely to be less well established.
"MIG-4"/"VMIG-4" - Loans bearing this designation are of adequate
quality, carrying specific risk but having protection commonly regarded as
required of an investment security and not distinctly or predominantly
speculative.
"SG" - Loans bearing this designation are of speculative quality and
lack margins of protection.
Fitch and Duff & Phelps 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 Portfolio may enter into futures
contracts and options thereon for hedging purposes. Such transactions are
described in this Appendix B.
I. MUNICIPAL BOND INDEX FUTURES CONTRACTS
A municipal bond index assigns relative values to the bonds included in
the index and the index fluctuates with changes in the market values of the
bonds so included. The Chicago Board of Trade has designed a futures contract
based on the Bond Buyer Municipal Bond Index. This Index is composed of a
number of term revenue and general obligation bonds, and its composition is
updated regularly as new bonds meeting the criteria of the Index are issued and
existing bonds mature. The Index is intended to provide an accurate indicator
of trends and changes in the municipal bond market. Each bond in the Index is
independently priced by six dealer-to-dealer municipal bond brokers daily. The
prices are then averaged and multiplied by a coefficient. The coefficient is
used to maintain the continuity of the Index when its composition changes. The
Chicago Board of Trade, on which futures contracts based on this Index are
traded, as well as other U.S. commodities exchanges, are regulated by the
Commodity Futures Trading Commission. Transactions on such exchange are cleared
through a clearing corporation, which guarantees the performance of the parties
to each contract.
The Portfolio will 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. The 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, the
Portfolio will purchase index futures contracts in anticipation of purchases of
securities. In a substantial majority of these transactions, the Portfolio will
purchase such securities upon termination of the long futures position, but a
long futures position may be terminated without a corresponding purchase of
securities.
Closing out a futures contract sale prior to the settlement date may be
effected by the Portfolio's entering into a futures contract purchase for the
same aggregate amount of the index involved and the same delivery date. If the
price in the sale exceeds the price in the offsetting purchase, the Portfolio is
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's
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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.
Example of a Municipal Bond Index Futures Contract
Consider a portfolio manager holding $1 million par value of each of
the following municipal bonds on February 2 in a particular year.
<TABLE>
<CAPTION>
Current Price
(points and
Maturity thirty-seconds
Issue Coupon Issue Date Date of a point)
- ----- ------ ---------- -------- --------------
<S> <C> <C> <C> <C>
Ohio HFA 9 3/8 5/05/83 5/1/13 94-2
NYS Power 9 3/4 5/24/83 1/1/17 102-0
San Diego, CA IDR 10 6/07/83 6/1/18 100-14
Muscatine, IA Elec 10 5/8 8/24/83 1/1/08 103-16
Mass Health & Ed 10 9/23/83 7/1/16 100-12
</TABLE>
The current value of the portfolio is $5,003,750.
To hedge against a decline in the value of the portfolio, resulting
from a rise in interest rates, the portfolio manager can use the municipal bond
index futures contract. The current value of the Municipal Bond Index is 86-09.
Suppose the portfolio manager takes a position in the futures market opposite to
his or her cash market position by selling 50 municipal bond index futures
contracts (each contract represents $100,000 in principal value) at this price.
On March 23, the bonds in the portfolio have the following values:
<TABLE>
<S> <C>
Ohio HFA 81-28
NYS Power 98-26
San Diego, CA IDB 98-11
Muscatine, IA Elec 99-24
Mass Health & Ed 97-18
</TABLE>
The bond prices have fallen, and the portfolio has sustained a loss of
$130,312. This would have been the loss incurred without hedging. However, the
Municipal Bond Index also has fallen, and its value stands at 83-27. Suppose
now the portfolio manager closes out his or her futures position by buying back
50 municipal bond index futures contracts at this price.
The following table provides a summary of transactions and the results
of the hedge.
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<TABLE>
<CAPTION>
Cash Market Futures Market
----------- --------------
<S> <C> <C>
February 2 $5,003,750 long posi- Sell 50 Municipal Bond
tion in municipal futures contracts at
bonds 86-09
March 23 $4,873,438 long posi- Buy 50 Municipal Bond
tion in municipal futures contracts at
bonds 83-27
--------------------- ----------------------
$130,312 Loss $121,875 Gain
</TABLE>
While the gain in the futures market did not entirely offset the loss
in the cash market, the $8,437 loss is significantly lower than the loss which
would have been incurred without hedging.
The numbers reflected in this appendix do not take into account the
effect of brokerage fees or taxes.
II. MARGIN PAYMENTS.
Unlike when the Portfolio purchases or sells a security, no price is
paid or received by the 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 Portfolio's custodian an amount of cash or
cash equivalents, the value of which may vary but is based upon the value of the
contract. This amount is known as initial margin. 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 the 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 adviser
may elect to
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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.
III. RISKS OF TRANSACTIONS IN FUTURES CONTRACTS.
There are several risks in connection with the use of futures by the
Portfolio as a hedging device. One risk arises because of the imperfect
correlation between movements in the price of the future and movements in the
price of the securities which are the subject of the hedge. The price of the
future may move more than or less than the price of the securities being hedged.
If the price of the future moves less than the price of the securities which are
the subject of the hedge, the hedge will not be fully effective but, if the
price of the securities 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 securities being hedged has moved in a favorable direction,
this advantage will be partially offset by the loss on the future. If the price
of the future moves more than the price of the hedged securities, the Portfolio
involved will experience either a loss or gain on the future which will not be
completely offset by movements in the price of the securities which are the
subject of the hedge. To compensate for the imperfect correlation of movements
in the price of securities 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 securities being hedged if the volatility over
a particular time period of the prices of such securities has been greater than
the volatility over such time period of the future, or if otherwise deemed to be
appropriate by the investment adviser. Conversely, the Portfolio may buy or sell
fewer futures contracts if the volatility over a particular time period of the
prices of the securities 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 adviser. It is also possible that, where the Portfolio has
sold futures to hedge its portfolio against a decline in the market, the market
may advance and the value of securities held in the Portfolio may decline. If
this occurred, the Portfolio would lose money on the future and also experience
a decline in value in its portfolio securities.
Where futures are purchased to hedge against a possible increase in the
price of securities before the Portfolio is able to invest its cash (or cash
equivalents) in securities (or options) in an orderly fashion, it is possible
that the market
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may decline instead; if the Portfolio then concludes not to invest in
securities or options 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 securities
purchased.
In instances involving the purchase of futures contracts by the
Portfolio, an amount of cash and cash equivalents, equal to the market value of
the futures contracts, will be deposited in a segregated account with the
Portfolio's custodian and/or in a margin account with a broker to collateralize
the position and thereby insure that the use of such futures is unleveraged.
In addition to the possibility that there may be an imperfect
correlation, or no correlation at all, between movements in the futures and the
securities being hedged, the price of futures may not correlate perfectly with
movement in the cash market due to certain market distortions. 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
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
Portfolio intends 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 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
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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.
Successful use of futures by the Portfolio is also subject to the
investment adviser's ability to predict correctly movements in the direction of
the market. For example, if the 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 of 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. The
Portfolio may have to sell securities at a time when it may be disadvantageous
to do so.
IV. OPTIONS ON FUTURES CONTRACTS.
The Portfolio may purchase 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.
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
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secondary market). In addition, the purchase of an option also entails the
risk that changes in the value of the underlying futures contract will not be
fully reflected 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).
V. ACCOUNTING AND TAX TREATMENT.
Accounting for futures contracts and related options will be in
accordance with generally accepted accounting principles.
Generally, futures contracts and options on futures contracts held by
the Portfolio at the close of the Portfolio's taxable year will be treated for
federal income tax purposes as sold for their fair market value on the last
business day of such year, a process known as "marking-to-market." Forty percent
of any gain or loss resulting from such constructive sale will be treated as
short-term capital gain or loss and 60% of such gain or loss will be treated as
long-term capital gain or loss without regard to the length of time the
Portfolio holds the futures contract or option ("the 40%-60% rule"). The amount
of any capital gain or loss actually realized by the Portfolio in a subsequent
sale or other disposition of those futures contracts or options will be adjusted
to reflect any capital gain or loss taken into account by the Portfolio in a
prior year as a result of the constructive sale of the contracts or options.
With respect to futures contracts to sell, which will be regarded as parts of a
"mixed straddle" because their values fluctuate inversely to the values of
specific securities held by the Portfolio, losses as to such contracts to sell
will be subject to certain loss deferral rules which limit the amount of loss
currently deductible on either part of the straddle to the amount thereof which
exceeds the unrecognized gain (if any) with respect to the other part of the
straddle, and to certain wash sales regulations. Under short sales rules, which
will also be applicable, the holding period of the securities forming part of
the straddle will (if they have not been held for the long-term holding period)
be deemed not to begin prior to termination of the straddle. With respect to
certain futures contracts and related options, deductions for interest and
carrying charges will not be allowed. Notwithstanding the rules described above,
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with respect to futures contracts to sell which are properly identified as
such, the Portfolio may make an election which will exempt (in whole or in
part) those identified futures contracts from being treated for federal income
tax purposes as sold on the last business day of the Portfolio's taxable year,
but gains and losses will be subject to such short sales, wash sales and loss
deferral rules and the requirement to capitalize interest and carrying charges.
Under Temporary Regulations, the Portfolio would be allowed (in lieu of the
foregoing) to elect either (1) to offset gains or losses from portions which
are part of a mixed straddle by separately identifying each mixed straddle to
which such treatment applies, or (2) to establish a mixed straddle account for
which gains and losses would be recognized and offset on a periodic basis
during the taxable year. Under either election, the 40%-60% rule will apply to
the net gain or loss attributable to the futures contracts, but in the case of
a mixed straddle account election, not more than 50 percent of any net gain may
be treated as long-term and no more than 40 percent of any net loss may be
treated as short-term.
Qualification as a regulated investment company under the Code requires
that the Portfolio satisfy certain requirements with respect to the source of
its income during a taxable year. At least 90% of the gross income of the
Portfolio must be derived from dividends, interests, payments with respect to
securities loans, gains from the sale or other disposition of stock, securities
or foreign currencies, and other income (including but not limited to gains from
options, futures, or forward contracts) derived with respect to the Portfolio's
business of investing in such stock, securities or currencies. The Treasury
Department may by regulation exclude from qualifying income foreign currency
gains which are not directly related to a fund's principal business of investing
in stock or securities, or options and futures with respect to stock or
securities. Any income derived by a fund from a partnership or trust is treated
for this purpose as derived with respect to the fund's business of investing in
stock, securities or currencies only to the extent that such income is
attributable to items of income which would have been qualifying income if
realized by the fund in the same manner as by the partnership or trust.
An additional requirement for qualification as a regulated investment
company under the Code is that less than 30% of the Portfolio's gross income
must be derived from gains realized on the sale or other disposition of the
following investments held for less than three months: (1) stock and securities
(as defined in section 2(a)(36) of the Investment Company Act of 1940); (2)
options, futures and forward contracts other than those on foreign currencies;
and (3) foreign currencies (and options, futures and forward contracts on
foreign currencies) that are not directly related to a fund's principal
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<PAGE> 383
business of investing in stock and securities (and options and futures with
respect to stocks and securities). With respect to futures contracts and other
financial instruments subject to the marking-to-market rules, the Internal
Revenue Service has ruled in private letter rulings that a gain realized from
such a futures contract or financial instrument will be treated as being
derived from a security held for three months or more (regardless of the actual
period for which the contract or instrument is held) if the gain arises as a
result of a constructive sale under the marking-to-market rules, and will be
treated as being derived from a security held for less than three months only
if the contract or instrument is terminated (or transferred) during the taxable
year (other than by reason of marking-to-market) and less than three months
have elapsed between the date the contract or instrument is acquired and the
termination date. In determining whether the 30% test is met for a taxable
year, increases and decreases in the value of the Portfolio's futures contracts
and other investments that qualify as part of a "designated hedge," as defined
in the Code, may be netted.
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