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PACIFIC HORIZON FUNDS, INC.
(THE "COMPANY")
STATEMENT OF ADDITIONAL INFORMATION
FOR
NATIONAL MUNICIPAL BOND FUND
CALIFORNIA MUNICIPAL BOND FUND
AGGRESSIVE GROWTH FUND
U.S. GOVERNMENT SECURITIES FUND
CAPITAL INCOME FUND
INTERMEDIATE BOND FUND
BLUE CHIP FUND
ASSET ALLOCATION FUND
FLEXIBLE INCOME FUND
INTERNATIONAL EQUITY FUND
SHORT-TERM GOVERNMENT FUND
July 1, 1998
(As Revised August 25, 1998)
TABLE OF CONTENTS
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THE COMPANY..........................................................................2
INVESTMENT OBJECTIVES AND POLICIES...................................................3
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION......................................42
ADDITIONAL INFORMATION CONCERNING TAXES.............................................51
MANAGEMENT..........................................................................56
GENERAL INFORMATION................................................................102
APPENDIX A.........................................................................A-1
APPENDIX B.........................................................................B-1
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This Statement of Additional Information applies to A, B and K Shares
of the Pacific Horizon Aggressive Growth Fund, Pacific Horizon U.S. Government
Securities Fund, Pacific Horizon Short-Term Government Fund, Pacific Horizon
Capital Income Fund, Pacific Horizon National Municipal Bond Fund, Pacific
Horizon California Municipal Bond Fund, Pacific Horizon Flexible Income Fund,
Pacific Horizon Asset Allocation Fund, Pacific Horizon International Equity Fund
(collectively, the "Non-Feeder Funds"), Pacific Horizon Intermediate Bond Fund
and Pacific Horizon Blue Chip Fund, (collectively, the "Feeder Funds" and,
collectively with the Non-Feeder Funds, the "Funds") of Pacific Horizon Funds,
Inc. (the "Company or "Pacific Horizon"). This Statement of Additional
Information also applies to SRF Shares of the Pacific Horizon Intermediate Bond
Fund, Pacific Horizon Blue Chip Fund and Pacific Horizon Asset Allocation Fund.
The Master Portfolios corresponding to the Intermediate Bond Fund and Blue Chip
Fund are referred to individually as the "Intermediate Bond Master Portfolio"
and "Blue Chip Master Portfolio," respectively, and collectively as
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the "Master Portfolios," and collectively with the Non-Feeder Funds, the
"Funds." The Company and Master Investment Trust, Series I ("Master Trust") are
collectively referred to herein as the "Companies." This Statement of Additional
Information is meant to be read in conjunction with the Prospectuses dated July
1, 1998, 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 A, B, K or SRF Shares of any Fund should be made
solely upon the information contained herein. Copies of the Prospectuses
relating to Pacific Horizon's Funds to which this Statement of Additional
Information relates may be obtained by calling Provident Distributors, Inc.
("PDI" or the "Distributor") at 800-346-2087. Capitalized terms used but not
defined herein have the same meaning as in the Prospectuses.
THE COMPANY
The Company was organized on October 27, 1982 as a Maryland
corporation. The National Municipal Bond Fund, Aggressive Growth Fund,
Intermediate Bond Fund (formerly, Flexible Bond Fund), Blue Chip Fund, Asset
Allocation Fund, International Equity Fund and Short-Term Government Fund
commenced operations on January 28, 1994, March 31, 1984, January 24, 1994,
January 13, 1994, January 18, 1994, May 13, 1996, and August 2, 1996,
respectively. The California Municipal Bond Fund (formerly, 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 Fund, 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 Pacific Horizon. 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
Flexible Income Fund (formerly, the Corporate Bond 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 "Corporate Predecessor Fund"). On April 25,
1994 the Corporate Predecessor Fund was reorganized as a separate portfolio of
the Company and all of the assets and liabilities of the Corporate Predecessor
Fund were transferred to the Flexible Income Fund.
The Feeder Funds seek to achieve their respective investment
objectives by investing substantially all of their assets in diversified
investment portfolios of an open end, management investment company having the
same investment objective as these Funds. Prior to July 1, 1996, September 1,
1996, September 1, 1996, June 23, 1997, the National Municipal Bond Fund,
Flexible Income Fund (formerly, the Corporate Bond Fund), International Equity
Fund and Asset Allocation Fund, respectively, invested all of their respective
assets in the National Municipal Bond Portfolio of Master Investment Trust,
Series, II ("Municipal Master Portfolio"); Corporate Bond Portfolio of Master
Investment Trust Series I ("Corporate Bond Master Portfolio"); International
Equity Portfolio of Master Investment Trust, Series I ("International Equity
Master Portfolio") and Asset Allocation
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Portfolio ("Asset Allocation Master Portfolio") of Master Investment Trust,
Series I. On July 1, 1996, September 1, 1996, September 1, 1996 and June 23,
1997, the National Municipal Bond Fund, Flexible Income Fund, International
Equity Fund and Asset Allocation Fund, respectively, withdrew their respective
assets from their respective master portfolios and invested them directly in
securities. The Intermediate Bond and Blue Chip Funds currently invest all of
their respective assets in the Investment Grade Bond Portfolio of Master
Investment Trust, Series I (the "Intermediate Bond Master Portfolio") and the
Blue Chip Portfolio of Master Trust (the "Blue Chip Master Portfolio"). The
Municipal Master Portfolio, International Equity Master Portfolio, Asset
Allocation Master Portfolio, Intermediate Bond Master Portfolio, Corporate Bond
Master Portfolio and Blue Chip Master Portfolio are singularly referred to as a
"Master Portfolio" and collectively as "Master Portfolios." Master Investment
Trust, Series I is referred to herein as the "Master Trust."
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. Because the investment
characteristics of each Feeder Fund will correspond with its respective Master
Portfolio, the following is a discussion of the various investments and
techniques employed by each Master 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. 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 or periods indicated, the portfolio
turnover rates for the National Municipal Bond Fund, U.S. Government Securities
Fund, California Municipal Bond Fund, Capital Income Fund, Aggressive Growth
Fund, Asset Allocation Fund, International Equity Fund, Short-Term Government
Fund, Flexible Income Fund, Intermediate Bond Master Portfolio and Blue Chip
Master Portfolio, were as follows:
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Year Ended Year or Period Ended
February 28, 1998 February 28, 1997
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National Municipal Bond Fund(1) 36% 12%
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U.S. Government Securities Fund 51% 94%
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California Municipal Bond Fund 28% 34%
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Capital Income Fund 69% 124%
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Aggressive Growth Fund 83% 99%
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Asset Allocation Fund(2) 67% 116%
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International Equity Fund(3) 79% 114%
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Short Term Government Fund(4) 82% 81%
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Flexible Income Fund(5) 63% 59%
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Intermediate Bond Master Portfolio 127% 83%
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Blue Chip Master Portfolio 67% 91%
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(1) Until July 1, 1996, the National Municipal Bond Fund invested all of its
assets in the Municipal Master Portfolio. Information contained in the chart
above includes portfolio turnover of the Municipal Master Portfolio.
(2) Until June 23, 1997, the Asset Allocation Fund invested all of its assets in
the Asset Allocation Master Portfolio. Information contained in the above chart
includes portfolio turnover of the Asset Allocation Master Portfolio.
(3) Until September 1, 1996, the International Equity Fund invested all of its
assets in the International Equity Master Portfolio. Information contained in
the chart above includes the portfolio turnover of the International Equity
Master Portfolio. Not annualized for period from May 13, 1996 (inception date)
to February 28, 1997.
(4) Not annualized for period from August 2, 1996 (inception date) to February
28, 1997.
(5) Until September 1, 1996, the Flexible Income Fund invested all of its assets
in the Corporate Bond Master Portfolio. Information contained in the chart above
includes portfolio turnover of the Corporate Bond Master Portfolio.
Subject to the general control of the Company's Board of
Directors, and the Master Portfolios' 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 Fund. Wellington Management
Company ("Wellington Management" or the "sub-adviser") serves as the
International Equity Fund's sub-adviser. References in this Statement of
Additional
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Information to Bank of America's action and responsibilities with respect to the
International Equity Fund shall be deemed to include Wellington Management
unless the context clearly indicates otherwise.
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 fixed income securities are
normally principal transactions without brokerage commissions.
For the fiscal years or periods indicated, the Aggressive
Growth Fund, Capital Income Fund, Blue Chip Master Portfolio, Asset Allocation
Fund, California Municipal Bond Fund, U.S. Government Securities Fund,
Intermediate Bond Master Portfolio, National Municipal Bond Fund, International
Equity Fund, and Short-Term Government Fund paid the following brokerage
commissions:
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Year Ended Year or Period Ended Year Ended
February 28, 1998 February 28, 1997 February 29, 1996
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Aggressive Growth Fund $296,651 $225,515 $369,002
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Capital Income Fund $137,371 $184,327 $ 95,126
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Blue Chip Master Portfolio $748,691 $637,281 $428,667
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Asset Allocation Fund+ $125,211 $152,270 $175,960
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California Municipal Bond Fund $0 $0 $0
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U.S. Government Securities
Fund $0 $0 $0
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Intermediate Bond Master
Portfolio $0 $0 $0
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National Municipal Bond Fund++ $0 $0 $0
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International Equity Fund+++ $181,774 $78,268 N/A
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Short-Term Government Fund++++ $0 $0 N/A
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Flexible Income Fund $0 $0 $0
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+ Until June 23, 1997, the Asset Allocation Fund invested all of its assets in
the Asset Allocation Master Portfolio. Information contained in the chart above
includes brokerage commissions paid by the Asset Allocation Master Portfolio.
++ Until July 1, 1996, the National Municipal Bond Fund invested all of its
assets in the Municipal Master Portfolio. Information contained in the chart
above includes brokerage expenses of the Municipal Master Portfolio.
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+++ The International Equity Fund commenced operations on May 13, 1996. Until
September 1, 1996 the International Equity Fund invested all of its assets in
the International Equity Master Portfolio. Information contained in the chart
above includes brokerage commissions paid by the International Equity Master
Portfolio.
++++ The Short-Term Government Fund commenced operations on August 2, 1996.
+++++ Until September 1, 1996, the Flexible Income Fund (formerly, the Corporate
Bond Fund) invested all of its assets in the Corporate Bond Master Portfolio.
Information contained in the chart above includes brokerage expenses of the
Corporate Bond Master Portfolio.
In executing portfolio transactions and selecting brokers or
dealers, it is the Funds' policy to seek the best overall terms available. The
Investment Advisory Agreements between the particular Company and Bank of
America and the Sub-Advisory Agreement with Wellington Management on behalf of
the International Equity Fund provide that, in assessing the best overall terms
available for any transaction, Bank of America or Wellington Management 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 and Sub-Advisory Agreements authorize Bank of America and
Wellington Management (with respect to the International Equity Fund), subject
to the approval of the particular Board, to cause a Fund 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 or Wellington Management to the particular Company or Fund. 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, a
particular 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 or
Wellington Management and do not reduce the advisory fee payable to Bank of
America or Wellington Management. Such services may be useful to Bank of America
or Wellington Management in serving both the Company, the Funds and other
clients and, conversely, services obtained by the placement of business of other
clients may be useful to Bank of America or Wellington Management in carrying
out the obligations to the Company and the Funds. In connection with the
investment management services with respect to the Funds, Bank of America or
Wellington Management will not acquire certificates of deposit or other
securities issued by them or their 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 Funds, Bank of America, Wellington Management,
the Distributor and their affiliates acting as principal, underwriter, syndicate
member, market-maker, dealer, broker or in any
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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 or Wellington Management, in their
sole discretion subject to guidelines adopted by the particular Board, believes
such practice to be in the interest of the Fund.
To the extent permitted by law, Bank of America or Wellington
Management 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.
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 Pacific Horizon as of the close of its most recent fiscal year.
As of February 28, 1998: (a) the Treasury Fund held the following securities:
Repurchase Agreement with Morgan Stanley Dean Witter & Co. in the principal
amount of $145,000,000; Repurchase Agreement with Lehman Brothers, Inc. in the
principal amount of $50,000,000; Repurchase Agreement with Merrill Lynch
Securities, Inc. in the principal amount of $145,000,000; and Repurchase
Agreement with Goldman Sachs & Co. in the principal amount of $574,667,000; (b)
the Government Fund held the following securities: Repurchase Agreement with
Morgan Stanley Dean Witter & Co. in the principal amount of $20,000,000;
Repurchase Agreement with Goldman Sachs & Co. in the principal amount of
$97,174,000; and Repurchase Agreement with Merrill Lynch Securities, Inc. in the
principal amount of $20,000,000; (c) the Prime Fund held the following
securities: Merrill Lynch & Co., Inc. commercial paper (2) in the principal
amounts of $25,000,000 and $100,000,000; Lehman Brothers Holdings, Inc.
commercial paper in the principal amount of $25,000,000; Merrill Lynch & Co.,
Inc. daily variable rate obligations (2) in the principal amounts of $25,000,000
and $25,000,000; Merrill Lynch & Co., Inc. weekly variable rate obligation in
the principal amount of $19,000,000; Dean Witter corporate obligation in the
principal amount of $15,000,000; Goldman Sachs Group L.P. master note in the
principal amount of $400,000,000; Morgan Stanley Group, Inc. master note in the
principal amount of $300,000,000; Bear Stearns Companies, Inc. daily variable
rate obligations (2) in the principal amounts of $75,000,000 and $60,000,000;
Bear Stearns Companies, Inc. monthly variable rate obligations (2) in the
principal amounts of $25,000,000 and $18,000,000; Lehman Brothers Holdings, Inc.
daily variable rate obligation in the principal amount of $50,000,000; Lehman
Brothers Holdings, Inc. weekly variable rate obligation in the principal amount
of $50,000,000; Lehman Brothers Holdings, Inc. quarterly variable rate
obligation in the principal amount of $36,000,000; Repurchase Agreement with
Morgan Stanley Dean Witter & Co. in the principal amount of $180,000,000;
Repurchase Agreements (2) with Goldman Sachs & Co. in the principal amounts of
$118,567,000 and $325,000,000; (d) the Corporate Bond Fund held the following
securities: Bear Stearns corporate obligation in the principal amount of
$400,000; and Merrill Lynch & Co., Inc. corporate obligation in the principal
amount of $1,500,000; (e) the Intermediate Bond Master Portfolio held the
following securities: Bear Stearns & Company corporate obligation in the
principal amount of $1,500,000; and Lehman Brothers Holdings medium term note in
the principal amount of $2,000,000; (f) the Asset Allocation Fund held the
following securities: Morgan Stanley Group, Inc. common stock in the amount of
$1,400,719; Bear Stearns & Co. medium term note in the principal amount of
$1,100,000; and Paine Webber Group medium term note in the principal amount of
$1,250,000; (g) the Blue Chip Master Portfolio held the following security:
Morgan
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<PAGE> 8
Stanley Dean Witter Discover & Co. common stock in the amount of $12,299,844;
(h) the International Equity Fund held the following security: Repurchase
Agreement with Paine Webber, Inc. in the amount of $5,784,000.
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 Fund as described in the Funds' Prospectuses,
except that the National Municipal Bond Fund and California Municipal Bond Fund
may not purchase time deposits. 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
may only be purchased from domestic or foreign banks and financial institutions
having 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 Intermediate Bond and
Blue Chip Master Portfolios and Asset Allocation Fund.
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.
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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 each Fund
other than the Capital Income and U.S. Government Securities Funds, 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 and U.S. Government Securities Funds; or
if unrated, will be determined by Bank of America or Wellington Management to be
of comparable quality under procedures established by the particular Board.
Other Investment Companies. In connection with the management of
their daily cash position, each Fund (including the Intermediate Bond and Blue
Chip Master Portfolios) may invest in the securities of other investment
companies (including money market mutual funds advised by Bank of America) whose
investment objectives are consistent with those of the Fund. Each Fund is also
permitted to invest the greater of 5% of their respective net assets or $2.5
million. As a shareholder of another investment company, a Fund would bear along
with other shareholders, its pro-rata portion of the other investment company's
expenses, including advisory fees. These expenses would be in addition to the
advisory and other expenses that the Fund bears directly in connection with its
own operations. The Aggressive Growth Fund may also acquire shares of closed-end
investment companies, including companies that invest in foreign issuers, but
only in furtherance of its investment objective. The International Equity Fund
may acquire shares of open and closed-end investment companies.
The 1940 Act generally 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 or sub-adviser.
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 which 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. Repurchase agreements maturing in more
than seven days are considered illiquid investments and investments in such
repurchase agreements along with any other illiquid securities will not exceed
15% of the value of the net assets of each Fund. The Funds are not permitted to
enter into repurchase agreements with
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<PAGE> 10
Bank of America, Wellington Management or their 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 Fund 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 or sub-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 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, Short-Term Government, U.S. Government
Securities, National Municipal Bond Fund, California Municipal Bond Fund, Asset
Allocation Fund, Flexible Income Fund, International Equity Fund, Intermediate
Bond Master Portfolio and Blue Chip Master Portfolio may acquire variable and
floating rate instruments including with respect to the Asset Allocation Fund,
Blue Chip and Intermediate Bond Master Portfolios, master demand notes. The
actual yield on variable and floating rate instruments varies not only as a
result of variations in the lives of the underlying securities, 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 or Wellington Management
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
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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 15% of net
assets limitation on illiquid securities. Variable and floating rate instruments
may be secured by bank letters of credit.
Municipal Securities. The U.S. Government Securities, Short-Term
Government and Asset Allocation Funds and Intermediate Bond Master Portfolio may
invest in Municipal Securities. The two principal classifications of Municipal
Securities 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 service such as the user of the facility being
financed. Private activity bonds held by the Funds are in most cases revenue
securities and are not payable from the unrestricted revenues of the issuer.
Consequently, the credit quality of such private activity bonds is usually
directly related to the credit standing of the corporate user of the facility
involved.
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 U.S. Government Securities, Short-Term Government and
Asset Allocation Funds and the Intermediate Bond Master Portfolio may also
invest in "moral obligation" securities, which are normally issued by special
purpose public authorities. If the issuer of moral obligation securities is
unable to meet its debt service obligations from current revenues, it may draw
on a reserve fund, the restoration of which is a moral commitment but not a
legal obligation of the state or municipality which created the issuer.
The California Municipal Bond, National Municipal Bond, U.S.
Government Securities, Short-Term Government and Asset Allocation Funds and the
Intermediate Bond Master 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. Those Funds 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 IBCA, Inc. ("Fitch IBCA") and Duff & Phelps
Credit Rating Co.
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("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 Municipal Securities of the same
maturity and interest rate with different ratings may have the same yield.
Subsequent to its purchase by a Fund, 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 a Fund 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 particular
Fund and the liquidity and value of the Fund. In such an event, the particular
Fund would re-evaluate its investment objective and policies and consider
changes in its structure or possible dissolution. Moreover, with respect to
Municipal Securities issued by the State of California, Pacific Horizon cannot
predict what legislation, if any, may be proposed in California.
Stand-By Commitments. The California Municipal Bond Fund and
National Municipal Bond Fund may acquire "stand-by commitments" with respect to
Municipal Securities held in their respective portfolios. Under a "stand-by
commitment," a dealer agrees to purchase from the particular Fund, at the Fund's
option, specified Municipal Securities at a specified price. "Stand-by
commitments" acquired by a Fund may also be referred to in this Statement of
Additional Information as "put" options.
The amount payable to the particular 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.
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The Funds expect that "stand-by commitments" will generally be
available without the payment of any direct or indirect consideration. However,
if necessary or advisable, the Funds 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 a Fund will not exceed 1/2
of 1% of the value of its total assets calculated immediately after each
"stand-by commitment" is acquired.
Each Fund intends to obtain "stand-by commitments" only from
dealers, banks and broker-dealers which, in the investment adviser's opinion,
present minimal credit risks. A 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.
Each 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 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 a Fund would be valued at zero in determining net asset value. Where
a 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.
Convertible Securities. The Capital Income Fund, Flexible
Income Fund and International Equity Fund may invest in 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 a Fund, the investment
adviser or sub-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 Fund as to issuers; and whether the
securities are rated by Moody's, S&P, D&P or Fitch IBCA 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 rise 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 investment value, the
price of the convertible securities is governed principally by their investment
value. To the extent the market price of the underlying
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<PAGE> 14
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.
The Funds 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.
Asset-Backed and Mortgage-Related Securities. The Short-Term
Government Fund, Flexible Income Fund, Intermediate Bond Master Portfolio, Asset
Allocation Fund and U.S. Government Securities Fund may purchase mortgage-backed
securities representing an undivided interest in a pool of mortgages that are
secured by entities, including but not limited to, the Government National
Mortgage Association ("GNMA"), Federal National Mortgage Association ("FNMA"),
Federal Home Loan Mortgage Corporation ("FHLMC"), commercial banks, trusts,
financial companies, finance subsidiaries of industrial companies, savings and
loan associations, mortgage banks and investment banks. These securities 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
security, 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.
There are a number of important differences among the
agencies, instrumentalities and sponsored enterprises of the U.S. Government
that issue mortgage-related securities and among the securities that they issue.
Mortgage-related securities guaranteed by the GNMA include GNMA Mortgage
Pass-Through Certificates (also known as "Ginnie Maes") which are guaranteed as
to the timely payment of principal and interest by GNMA and such guarantee is
backed by the full faith and credit of the United States. GNMA is a wholly-owned
U.S. Government corporation within the Department of Housing and Urban
Development. GNMA certificates also are supported by the authority of GNMA to
borrow funds from the U.S. Treasury to make payments under its guarantee.
Mortgage-related securities issued by the FNMA include FNMA Guaranteed Mortgage
Pass-Through Certificates (also known as "Fannie Maes") which are solely the
obligations of the FNMA and are not backed by or entitled to the full faith and
credit of the United States, but are supported by the right of the issuer to
borrow from the Treasury. FNMA is a government-sponsored organization owned,
entirely by private stockholders. Fannie Maes are guaranteed as to timely
payment of the principal and interest by FNMA. Mortgage-related securities
issued by the FHLMC include FHLMC Mortgage Participation Certificates (also
known as "Freddie Macs" or "Pcs"). FHLMC is a corporate instrumentality of the
United States, created pursuant to an Act of Congress, which is owned entirely
by Federal Home Loan Banks. Freddie Macs are not guaranteed by the United States
or by any Federal Home Loan Bank, and do not
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<PAGE> 15
constitute a debt or obligation of the United States or of any Federal Home Loan
Bank. Freddie Macs entitle the holder to timely payment of interest, which is
guaranteed by FHLMC. FHLMC guarantees either ultimate collection or timely
payment of all principal payments on the underlying mortgage loans. When FHLMC
does not guarantee timely payment of principal, FHLMC may remit the amount due
on account of its guarantee of ultimate payment of principal at any time after
default on an underlying mortgage, but in no event later than one year after it
becomes payable.
The U.S. Government Securities Fund and Short-Term Government
Fund may invest in multiple class pass-through securities, including
collateralized mortgage obligations ("CMOs") and real estate mortgage investment
conduits ("REMIC") pass-through or participation certificates ("REMIC
Certificates"). These multiple class securities may be issued by U.S. Government
agencies, instrumentalities, or sponsored enterprises including FNMA and FHLMC,
or by trusts formed by private originators of, or investors in, mortgage loans.
In general, CMOs and REMICs are debt obligations of a legal entity that are
collateralized by, and multiple class pass-through securities represent direct
ownership interests in, a pool of residential mortgage loans or mortgage
pass-through securities (the "Mortgage Assets"), the payments on which are used
to make payments on the CMOs or multiple pass-through securities. Investors may
purchase beneficial interests in REMICs, which are known as "regular" interests
or "residual" interests. The Fund does not intend to purchase residual
interests.
Each class of CMOs or REMIC Certificates, often referred to as a
"tranche," is issued at a specific adjustable or fixed interest rate and must be
fully retired no later than its final distribution date. Principal prepayments
on the Mortgage Assets underlying the CMOs or REMIC Certificates may cause some
or all of the classes of CMOs or REMIC Certificates to be retired substantially
earlier than their final distribution dates. Generally, interest is paid or
accrues on all classes of CMOs or REMIC Certificates on a monthly basis.
The principal of and interest on the Mortgage Assets may be allocated
among the several classes of CMOs or REMIC Certificates in various ways. In
certain structures (known as "sequential pay" CMOs or REMIC Certificates),
payments of principal, including any principal prepayments, on the Mortgage
Assets generally are applied to the classes of CMOs or REMIC Certificates in the
order of their respective final distribution dates. Thus no payment of principal
will be made on any class of sequential pay CMOs or REMIC Certificates until all
other classes having an earlier final distribution date have been paid in full.
Additional structures of CMOs or REMIC Certificates include, among
others, "parallel pay" CMOs and REMIC Certificates. Parallel pay CMOs or REMIC
Certificates are those which are structured to apply principal payments and
prepayments of the Mortgage Assets to two or more classes concurrently on a
proportionate or disproportionate basis. These simultaneous payments are taken
into account in calculating the final distribution date of each class.
A wide variety of REMIC Certificates may be issued in the parallel pay
or sequential pay structures. These securities include accrual certificates
(also known as "Z-Bonds"), which only accrue interest at a specified rate until
all other certificates having an earlier final distribution date have been
retired and are converted thereafter to an interest-paying security, and planned
amortization class ("PAC") certificates, which are parallel pay REMIC
Certificates which generally require that specified amounts of principal be
applied on each payment date to one or more classes of REMIC Certificates (the
"PAC Certificates"), even though all other principal payments and prepayments of
the Mortgage Assets are then required to be applied to one or more other classes
of the Certificates. The scheduled principal payments for the PAC Certificates
generally have the highest
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<PAGE> 16
priority on each payment date after interest due has been paid to all classes
entitled to receive interest currently. Shortfalls, if any, are added to the
amount payable on the next payment date. The PAC Certificate payment schedule is
taken into account in calculating the final distribution date of each class of
PAC. In order to create PAC tranches, one or more tranches generally must be
created that absorb most of the volatility in the underlying Mortgage Assets.
These tranches tend to have market prices and yields that are much more volatile
than the PAC classes.
FNMA REMIC Certificates are issued and guaranteed as to timely
distribution of principal and interest by FNMA. In addition, FNMA will be
obligated to distribute on a timely basis to holders of FNMA REMIC Certificates
required installments of principal and interest and to distribute the principal
balance of each class of REMIC Certificates in full, whether or not sufficient
funds are otherwise available.
For FHLMC REMIC Certificates, FHLMC guarantees the timely payment of
interest, and also guarantees the ultimate payment of principal as payments are
required to be made on the underlying mortgage participation certificates
("Pcs"). Pcs represent undivided interests in specified level payment,
residential mortgages or participation therein purchased by FHLMC and placed in
a PC pool. With respect to principal payments on Pcs, FHLMC generally guarantees
ultimate collection of all principal of the related mortgage loans without
offset or deduction. FHLMC also guarantees timely payment of principal on
certain Pcs, referred to as "Gold Pcs."
The Flexible Income Fund, Asset Allocation Fund, Intermediate
Bond Master Portfolio, Short-Term Government Fund and U.S. Government Securities
Fund 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 of a special purpose entity organized solely for the purpose of owning such
assets and issuing such debt. Non-mortgage backed securities may not be 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
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<PAGE> 17
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 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 for the Flexible Income Fund 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.
Zero Coupon Securities. The California Municipal Bond Fund and
National Municipal Bond Fund 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.
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).
Reverse Repurchase Agreements. As described in the
Prospectuses, each Fund (except the Short-Term Government 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 segregate liquid assets such
as cash, U.S. Government securities or other liquid high grade securities having
a value equal to the repurchase price (including accrued interest), and Bank of
America or Wellington Management will subsequently continuously monitor the
account for maintenance of such equivalent value. Each Fund 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 a Fund under the 1940
Act.
Options Trading. A Fund may, under certain circumstances and
in accordance with investment limitations described in its prospectus, engage in
options trading. Such options may relate to U.S. and foreign
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securities or to various stock indices. In addition, a Fund may acquire options
relating to foreign currencies in order to hedge against changes in exchange
rates. Such options may be traded on U.S. exchanges, over-the-counter, and on
foreign exchanges to the extent permitted by law. The International Equity Fund
may also invest in futures for the purposes of adjusting country exposure,
hedging or income enhancement.
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 premium paid 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 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. Unlisted options are not
subject to the protections afforded purchases 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 SEC 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
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.
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.
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
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<PAGE> 19
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 it owns 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.
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 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.
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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 Funds may engage in futures contracts. The
International Equity Fund may also invest in futures for the purposes of
adjusting country exposure, hedging or income enhancement. 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. A Fund 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 Fund under the rules of the
exchange on which the futures contract (or futures option) is traded, plus any
premiums paid by the Fund on its open futures options positions, does not exceed
5% of the Fund's total assets, after taking into account any unrealized profits
and losses on the Fund'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 Fund is subject to
Bank of America's or Wellington Management'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 Fund as a
hedging device. 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 the 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
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 futures contract. If the
price of the futures contract moves more than the price of the hedged
securities, a Fund 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 Fund 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 Fund may decline. If this
occurred, a Fund 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 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 or Wellington
Management may still not result in a successful hedging transaction over a short
time frame.
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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 Funds 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 Fund 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.
Options on Futures Contracts. The acquisition of put and call
options on a futures contract will give a Fund 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 Fund 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 a Fund's assets. By
writing a call option, a Fund 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 contract generates a
premium, which may partially offset an increase in the price of securities that
the Fund intends to purchase. However, the Fund becomes obligated to purchase a
futures contract, which may have a value lower than the exercise price. Thus,
the loss incurred by the Fund in writing options on futures is potentially
unlimited and may exceed the amount of the premium received. The Fund 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. A
Fund's ability to establish and close out positions on such options will be
subject to the development and maintenance of a liquid market.
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 Flexible Income Fund and Bank of
America believe that swaps do not constitute senior securities as defined in the
1940 Act and, accordingly, will not treat them as being subject to the Fund's
borrowing restrictions. The net amount of the excess, if any, of the Flexible
Income Fund'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 Fund's custodian. The Flexible Income
Fund will not enter into any interest rate or currency swap unless the credit
quality of the unsecured
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<PAGE> 22
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 Flexible Income Fund 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
standard 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 considering whether to invest in the
securities of a foreign company, Bank of America or Wellington Management
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 U.S. Government Securities Fund, Short-Term Government
Fund, Flexible Income Fund, Intermediate Bond Master Portfolio, Asset Allocation
Fund and International Equity Fund may invest in securities of foreign issuers
that may or may not be publicly traded in the United States. The Aggressive
Growth Fund may invest up to 20% of its total assets, either directly, or
indirectly through investments in American Depositary Receipts ("ADRs") and
closed-end investment companies, in securities issued by foreign companies
wherever organized. The Capital Income Fund may invest up to 15% 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 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. The extent to which a Fund will be invested in foreign
companies and ADRs will fluctuate from time to time within the limits stated in
the Prospectuses depending on the investment adviser's or sub-adviser's
assessment of prevailing market, economic and other conditions.
The International Equity Fund may purchase debt obligations
issued or guaranteed by governments (including states, provinces or
municipalities) of countries other than the United States, or by their agencies,
authorities or instrumentalities. The International Equity Fund and the Flexible
Income Fund may purchase debt obligations issued or guaranteed by supranational
entities organized or supported by several national governments, such as the
International Bank for Reconstruction and Development (the "World Bank"), the
Inter-American Development Bank, the Asian Development Bank and the European
Investment Bank. The International Equity Fund also may purchase debt
obligations of foreign corporations or financial institutions, such as Yankee
bonds (dollar-denominated bonds sold in the United States by non-U.S. issuers),
Samurai bonds (yen-denominated bonds sold in Japan by non-Japanese issuers and
Euro bonds (bonds not issued in the country (and possibly currency of the
country) of the issuer). The International Equity Fund's investments will be
allocated among securities denominated in the currencies of a number of foreign
countries and, within each such country, among different types of debt
securities. The percentage of assets invested in securities of a particular
country or denominated in a particular currency will vary in accordance with
Bank of America's or Wellington
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<PAGE> 23
Management's assessment of the country's gross domestic product, purchasing
power parity and market capitalization and the relationship of a country's
currency to the United States dollar. Fundamental economic strength, credit
quality and interest rate trends will be the principal factors considered by
Bank of America or Wellington Management in determining whether to increase or
decrease the emphasis placed upon a particular type of security within the
International Equity Fund.
Fixed commissions on foreign securities exchanges are
generally higher than negotiated commissions on U.S. exchanges, although the
Funds endeavor to achieve the most favorable net results on its portfolio
transactions. There is generally less government supervision and regulation of
securities exchanges, brokers, dealers and listed companies than in the United
States. Mail service between the United States and foreign countries may be
slower or less reliable than within the United States, thus increasing the risk
of delayed settlements of portfolio transactions or loss of certificates for
portfolio securities.
Foreign markets also have different clearance and settlement
procedures, and in certain markets there have been times when settlements have
been unable to keep pace with the volume of securities transactions, making it
difficult to conduct such transactions. Such delays in settlement could result
in temporary periods when a portion of the assets of a Fund is uninvested and no
return is earned thereon. The inability of the Funds to make intended security
purchases due to settlement problems could cause a Fund to miss attractive
investment opportunities. Inability to dispose of portfolio securities due to
settlement problems could result either in losses to the Funds due to subsequent
declines in value of the portfolio securities, or, if a Fund has entered into a
contract to sell the securities, could result in possible liability to the
purchaser. Individual foreign economies may differ favorably or unfavorably from
the U.S. economy in such respects as growth or gross national product, rate of
inflation, capital reinvestment, resource self-sufficiency and balance of
payments position.
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.
The expected introduction of a single currency, the European
Currency Unit ("Euro"), on January 1, 1999 for participating nations in the
European Economic and Monetary Union presents unique uncertainties, including
whether the payment and operational systems of banks and other financial
institutions will be ready by the scheduled launch date; the legal treatment of
certain outstanding financial contracts after January 1, 1999 that refer to
existing currencies rather than the Euro; the establishment of exchange rates
for existing currencies and the Euro; and the creation of suitable clearing and
settlement payment systems for the new currency. These or other factors,
including political and economic risks, could cause market disruptions before or
after the introduction of the Euro, and could adversely affect the value of
securities held by the Funds.
Bonds of Supranational Entities. The Flexible Income Fund and
International Equity Fund may invest in bonds of supranational entities. A
supranational entity is an entity established or financially supported
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<PAGE> 24
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 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. The risks associated with
investments in foreign issuers are described above under "Foreign Investments."
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 Asset Allocation, Blue Chip and Intermediate
Bond Master Funds.
When-Issued Securities, Forward Commitments and Delayed
Settlements. All Funds may agree to purchase securities on a "when-issued," and
"forward commitment" basis. All Funds except for the Asset Allocation Fund,
Intermediate Bond and Blue Chip Master Portfolios may agree to purchase
securities on a "delayed settlement" basis. 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. It may be expected that the net assets of a 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 Funds do not intend
to engage in these transactions for speculative purposes but primarily in order
to hedge against anticipated changes in interest rates. 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 or
sub-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 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,
U.S. Government Securities, Flexible Income, Asset Allocation and International
Equity Funds and Blue Chip Master Portfolio 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
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<PAGE> 25
collateral must be at all times equal to at least the market value of the
securities loaned and is "marked to market" daily. 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,
International Equity and Flexible Income Funds, cash collateral may be invested
in short-term U.S. Government securities, certificates of deposit, other
high-grade, short-term obligations or interest-bearing cash equivalents.
Additionally, the International Equity Fund may also invest cash collateral in
U.S. Treasury notes. 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 a fund if a material event
affecting the investment is to occur.
Illiquid Securities. It is possible that unregistered
securities purchased by a Non-Feeder Fund, in reliance upon Rule 144A under the
Securities Act of 1933 (the "1933 Act") could have the effect of increasing the
level of such Fund's illiquidity to the extent that qualified institutional
buyers become, for a period, uninterested in purchasing these securities.
ADDITIONAL INFORMATION - FLEXIBLE INCOME FUND, CAPITAL INCOME FUND, NATIONAL
MUNICIPAL BOND FUND AND CALIFORNIA MUNICIPAL BOND 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 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
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<PAGE> 26
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.
Custodial Receipts and Participation Interest. Securities
acquired by the California Municipal Bond Fund and National Municipal Bond 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 California Municipal Bond Fund and National Municipal Bond
Fund and the Flexible Income Fund may acquire give the Funds 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 SEC (although the securities held by the issuer may have
longer maturities). If a participation interest is unrated, the investment
adviser will have determined that the interest is of comparable quality to those
instruments in which each Fund may invest pursuant to guidelines approved by the
particular Board. For certain participation interests, each Fund will have the
right to demand payment, on not more than 30 days' notice, for all or any part
of its participation interest, plus accrued interest. As to these instruments,
each 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).
ADDITIONAL INFORMATION - ALL FUNDS
The investment adviser's or sub-adviser's own investment
portfolios may include bank certificates of deposit, bankers' acceptances,
corporate debt obligations, equity securities and other investments any of which
may also be purchased by a Fund. The Funds may also invest in securities,
interests or obligations of companies or entities which have a deposit, loan,
commercial banking or other business relationship with Bank of America or any of
its affiliates (including outstanding loans to such issuers which may be repaid
in whole or in part with the proceeds of securities purchased by a Fund).
SPECIAL CONSIDERATIONS RELATING TO CALIFORNIA MUNICIPAL SECURITIES
This summary does not purport to be a comprehensive
description of all relevant facts. Although the Company has no reason to believe
that the information summarized herein is not correct in all material
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<PAGE> 27
respects, this information has not been independently verified for accuracy or
thoroughness by the Company. Rather, the information presented herein has been
culled from official statements and prospectuses issued in connection with
various securities offerings of the State of California and local agencies in
California, available as of the date of this Statement of Additional
Information. Further, the estimates and projections presented herein should not
be construed as statements of fact. They are based upon assumptions which may be
affected by numerous factors and there can be no assurance that target levels
will be achieved. 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.
ECONOMIC FACTORS
FISCAL YEARS PRIOR TO 1995-96. Pressures on the State's budget
in the late 1980's and early 1990's were caused by a combination of external
economic conditions and growth of the largest General Fund Program - K-14
education, health, welfare and corrections -- at rates faster than the revenue
base. These pressures could continue as the State's overall population and
school age population continue to grow, and as the State's corrections program
responds to a "Three Strikes" law enacted in 1994, which requires mandatory life
prison terms for certain third-time felony offenders. In addition, the State's
health and welfare programs are in a transition period as result of recent
federal and State welfare reform initiatives.
As a result of these factors and others, and especially
because a severe recession between 1990-94 reduced revenues and increased
expenditures for social welfare programs, from the late 1980's until 1992-93,
the State had period of significant budget imbalance. During this period,
expenditures exceeded revenues in four out of six years, and the State
accumulated and sustained a budget deficit in its budget reserve, the Special
Fund for Economic Uncertainties ("SFEU") approaching $2.8 billion at its peak at
June 30, 1993. Between the 1991-92 and 1994-95 Fiscal Years, each budget
required multibillion dollar actions to bring projected revenues and
expenditures into balance, including significant cuts in health and welfare
program expenditures; transfers of program responsibilities and funding from the
State to local governments; transfers of about $3.6 billion in annual local
property tax revenues from other local governments to local school districts,
thereby reducing State funding for schools under Proposition 98; and revenue
increases (particularly in the 1991-92 Fiscal Year budget), most of which were
for a short duration.
Despite these budget actions, as noted, the effects of the
recession led to large, unanticipated deficits in the SFEU, as compared to
projected positive balances. By the 1993-94 Fiscal Year, the accumulated deficit
was so large that it was impractical to budget to retire such deficits in one
year, so a two-year program was implemented, using the issuance of revenue
anticipation warrants to carry a portion of the deficit over to the end of the
fiscal year. When the economy failed to recover sufficiently in 1993-94, a
second two-year Plan was implemented in 1994-95, again using cross-fiscal year
revenue anticipation warrants to partly finance the deficit into the 1995-96
fiscal year.
Another consequence of the accumulated budget deficits,
together with other factors such as disbursement of funds to local school
districts "borrowed" from future fiscal years and hence not shown in the annual
budget, was to significantly reduce the State's cash resources available to pay
its ongoing obligations. When the Legislature and the Governor failed to adopt a
budget for the 1992-93 Fiscal Year by July 1, 1992, which would have allowed the
State to carry out its normal annual cash flow borrowing to replenish cash
reserves, the State Controller issued registered warrants to pay a variety of
obligations representing prior years' or continuing appropriations, and mandates
from court orders. Available funds were used to make
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<PAGE> 28
constitutionally-mandated payments, such as debt service on bonds and warrants.
Between July 1 and September 4, 1992, when the budget was adopted, the State
Controller issued a total of approximately $3.8 billion of registered warrants.
For several fiscal years during the recession, the State was
forced to rely on external debt markets to meet its cash needs, as a succession
of notes and revenue anticipation warrants were issued in the period from June
1992 to July 1994, often needed to pay previously maturing notes or warrants.
These borrowings were used also in part to spread out the repayment of the
accumulated budget deficit over the end of a fiscal year, as noted earlier. The
last and largest of these borrowings was $4.0 billion of revenue anticipation
warrants which were issued in July, 1994 and matured on April 25, 1996.
1995-96 AND 1996-97 FISCAL YEARS
With the end of the recession, and a growing economy beginning
in 1994, the State's financial condition improved markedly in the last two
fiscal years, with a combination of better than expected revenues, slowdown in
growth of social welfare programs, and continued spending restraint based on the
actions taken in earlier years. The last of the recession-induced budget
deficits was repaid, allowing the SFEU to post a positive cash balance for only
the second time in the 1990's, totaling $281 million as of June 30, 1997. The
State's cash position also returned to health, as cash flow borrowing was
limited to $3 billion in 1996-97, and no deficit borrowing has occurred over the
end of these last two fiscal years.
In each of these two fiscal years, the State budget contained
the following major features:
1. Expenditures for K-14 schools grew significantly, as new
revenues were directed to school spending under Proposition 98. This new money
allowed several new education initiatives to be funded, and raised K-12
per-pupil spending to around $4,900 by Fiscal Year 1996-97. See "STATE FINANCES"
- - Proposition 98".
2. The Budgets restrained health and welfare spending levels,
holding to reduced benefit levels enacted in earlier years, and attempted to
reduce General Fund spending by calling for greater support from the federal
government. The State also attempted to shift to the federal government a larger
share of the cost of incarceration and social services for illegal aliens. Some
of these efforts were successful, and federal welfare reform also helped, but as
a whole the federal support never reached the levels anticipated when the
budgets were enacted. These funding shortfalls were, however, filled by the
strong revenue collections, which exceeded expectations.
3. General Fund support for the University of California and
the California State University system grew by an average of 5.2 percent and 3.3
percent per year, respectively, and there were no increases in student fees.
4. General Fund support for the Department of Corrections grew
as needed to meet increased prison population. No new prisons were approved for
construction, however.
5. There were no tax increases, and starting January 1, 1997,
there was a 5 percent cut in corporate taxes. The suspension of the Renter's Tax
Credit, first taken as a cost-saving measure during the recession, was
continued.
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As noted, the economy grew strongly during these fiscal years,
and as a result, the General Fund took in substantially greater tax revenues
(about $2.2 billion in 1995-96 and $1.6 billion in 1996-97) than were initially
planned when the budgets were enacted. These additional funds were largely
directed to school spending as mandated by Proposition 98, and to make up
shortfalls from reduced federal health and welfare aid. As a result, there was
no dramatic increase in budget reserves, although the accumulated budget deficit
from the recession years was finally eliminated in the past fiscal year.
1997-98 FISCAL YEAR
Background
On January 9, 1997, the Governor released his proposed budget
for the 1997-98 Fiscal Year (the "Proposed Budget"). The Proposed Budget
estimated General Fund revenues and transfers of about $50.7 billion, and
proposed expenditures of $50.3 billion, resulting in an anticipated budget
reserve in the SFEU of about $550 million. The Proposed Budget included
provisions for a further 10% cut in Bank and Corporation Taxes, which ultimately
was not enacted by the Legislature.
At the time of the Department of Finance May Revision,
released on May 14, 1997, the Department of Finance increased it revenue
estimate for the upcoming fiscal year by $1.3 billion, in response to the
continued strong growth in the State's economy. Budget negotiations continued
into the summer, with major issues to be resolved including final agreement on
State welfare reform, an increase in State employee salaries and consideration
of the tax cut proposed by the Governor.
In May, 1997, action was taken by the California Supreme Court
in an ongoing lawsuit, PERS v. Wilson, below, which made final a judgment
against the State requiring an immediate payment from the General Fund to the
Public Employees Retirement Fund ("PERF") to make up certain deferrals in annual
retirement fund contributions which had been legislated in earlier years for
budget savings, and which the courts found to be unconstitutional. On July 30,
1997, following a direction from the Governor, the Controller transferred $1.235
billion from the General Fund to the PERF in satisfaction of the judgment,
representing the principal amount of the improperly deferred payments from
1995-96 and 1996-97. In late 1997, the plaintiffs filed a claim with the State
Board of Control for payment of interest under the Court rulings in an amount of
$308 million. The Department of Finance has recommended approval of this claim.
If approved by the Board of Control, the claim would become part of an annual
claims bill in the 1998-99 Budget.
FISCAL YEAR 1997-98 BUDGET ACT
Following the transfer of funds to the PERF, final agreement
was reached within a few weeks on the welfare package and remainder of the
budget. The Legislature passed the Budget Bill on August 11, 1997, along with
numerous related bills to implement its provisions. Agreement was not finally
reached at that time on one aspect of the budget plan, concerning the Governor's
proposal for a comprehensive educational testing program.
On August 18, 1997, the Governor signed the Budget Act, but
vetoed about $314 million of specific spending items, primarily in health and
welfare and education areas from both the General Fund and
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Special Funds. Approximately $200 million of this amount was restored in
subsequent legislation passed before the end of the Legislative Session.
The Budget Act anticipated General Fund revenues and transfers
of $52.5 billion (a 6.8 percent increase over the final 1996-97 amount), and
expenditures of $52.8 billion (an 8.0 percent increase from the 1996-97 levels).
The Budget Act also included Special Fund expenditures of $14.4 billion (as
against estimated Special Fund revenues of $14 billion), and $2.1 billion of
expenditures from various Bond Funds. Subsequent to the Budget Act enactment,
the State undertook its normal cash flow borrowing program by issuing $3 billion
of Notes which mature June 30, 1998.
The following were major features of the 1997-98 Budget Act:
1. For the second year in a row, the Budget contained a large
increase in funding for K-14 education under Proposition 98, reflecting strong
revenues which have exceeded initial budgeted amounts. Part of the nearly $1.75
billion in increased spending was allocated to prior fiscal years. Funds were
provided to fully pay for the cost-of-living- increase component of Proposition
98, and to extend the class size reduction and reading initiatives. See "STATE
FINANCES Proposition 98.
2. The Budget Act reflected the $1.228 billion pension case
judgment payment, and brings funding of the State's pension contribution back to
the quarterly basis which existed prior to the deferral actions which were
invalidated by the courts.
3. Continuing the third year of a four-year "compact" which
the Administration had made with higher education units, funding from the
General Fund for the University of California and the California State
University system was increased by approximately 6 percent ($121 million and
$107 million, respectively). There was no increase in student fees.
4. Because of the effect of the pension payment, most other
State programs were continued at 1996-97 levels, adjusted for caseload changes.
5. Health and welfare costs were contained, continuing
generally the grant levels from prior years, as part of the initial
implementation of the new CalWORKs program.
6. Unlike prior years, this Budget Act did not depend on
uncertain federal budget actions. About $300 million in general funds, already
included in the federal FY 1997 and 1998 budgets, were included in the Budget
Act, to offset incarceration costs for illegal aliens.
7. The Budget Act contained no tax increases, and no tax
reductions. The Renters Tax Credit was suspended for another year, saving
approximately $500 million. The Legislature has not made any decision on
conformity of State tax laws to the recent federal tax reduction bill; a
comprehensive review of this subject is expected to take place next year.
At the end of the Legislative Session on September 13, 1997,
the Legislature passed and the Governor later signed several bills encompassing
a coordinated package of fiscal reforms, mostly to take effect after the 1997-98
Fiscal Year. Included in the package are a variety of phased-in tax cuts,
conformity with certain provisions of the federal tax reform law passed earlier
in the year, and reform of funding for county trial
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courts, with the State to assume greater financial responsibility. The
Department of Finance estimates that the major impact of these fiscal reforms
will occur in Fiscal Year 1998-99 and subsequent years.
The Department of Finance released updated estimates for the
1997-98 Fiscal Year on January 9, 1998 as part of the Governor's 1998-99 Fiscal
Year Budget Proposal. Total revenues and transfers are projected at $52.9
billion, up approximately $360 million from the Budget Act projection.
Expenditures for the fiscal year are expected to rise approximately $200 million
above the original Budget Act, to $53 billion. The balance in the budget
reserve, the SFEU, is projected to be $329 million at June 30, 1998, compared to
$461 million at June 30, 1997.
PROPOSED 1998-99 FISCAL YEAR BUDGET
On January 9, 1998, the Governor released his Budget Proposal
for the 1998-99 Fiscal Year (the "Governor's Budget"). The Governor's Budget
projects total General Fund revenues and transfers of $55.4 billion, a $2.5
billion increase (4.7 percent) over revised 1997-98 revenues. This revenue
increase takes into account reduced revenues of approximately $600 million from
the 1997 tax cut package, but also assumes approximately $500 million additional
revenues primarily associated with capital gains realizations. The Governor's
Budget notes, however, that capital gains activity and the resultant revenues
derived from it are very hard to predict.
Total General Fund expenditures for 1998-99 are recommended at
$55.4 billion, an increase of $2.4 billion (4.5 percent) above the revised
1997-98 level. The Governor's Budget includes funds to pay the interest claim
relating to the court decision on pension fund payments PERS v. Wilson (See
"1997-98 Fiscal Year" above). The Governor's Budget projects that the State will
carry out its normal intra-year cash flow external borrowing in 1998-99, in an
estimated amount of $3 billion. The Governor's Budget projects that the budget
reserve, the SFEU, will be $296 million at June 30, 1999, slightly lower than
the projected level at June 30, 1998 PERS liability.
The Governor's Budget projects Special Fund revenues of $14.7
billion, and Special Fund expenditures of $15.2 billion, in the 1998-99 Fiscal
Year. A total of $3.2 billion of bond fund expenditures are also proposed.
THE ORANGE COUNTY BANKRUPTCY. 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. The subsequent
restructuring led to the sale of substantially all of the Pool's portfolio and
resulted in losses estimated to be approximately $1.7 billion (or approximately
22% of amounts deposited by the Pool investors). Approximately 187 California
public entities -- substantially all of which are public agencies within the
county -- had various bonds, notes or other forms of indebtedness outstanding.
In some instances the proceeds of such indebtedness were invested in the Pool.
In April, 1996, the County emerged from bankruptcy after
closing on a $900 million recovery bond transaction. At that time, the County
and its financial advisors stated that the County had emerged from the
bankruptcy without any structural fiscal problems and assured that the County
would not slip back into bankruptcy. However, for many of the cities, schools
and special districts that lost money in the County portfolio, repayment remains
contingent on the outcome of litigation which is pending against investment
firms
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and other finance professionals. Thus, it is impossible to determine the
ultimate impact of the bankruptcy and its aftermath on these various agencies
and their claims.
In May 1996, a taxpayer action was filed against the City of San
Diego ("San Diego") and the San Diego Convention Center Expansion Authority (the
"Authority") challenging the validity of a lease revenue financing involving a
lease (the "San Diego Lease") having features similar to the leases commonly
used in California lease-based financings such as certificates of participation
(the "Rider Case"). The Rider Case plaintiffs alleged that voter approval is
required for the San Diego Lease (a) since the lease constituted indebtedness
prohibited by Article XVI, Section 18 of the California Constitution without a
two-thirds vote of the electorate, and (b) since San Diego was prohibited under
its charter from issuing bonds without a two-thirds vote of the electorate, and
the power of the Authority, a joint powers' authority, one of the members of
which is San Diego, to issue bonds is no greater than the power of San Diego. In
response to San Diego's motion for summary judgment, the trial court rejected
the plaintiffs' arguments and ruled that the San Diego Lease was
constitutionally valid and that the Authority's related lease revenue bonds did
not require voter approval. The plaintiffs appealed the matter to the Court of
Appeals for the Fourth District, which affirmed the validity of the San Diego
Lease and of the lease revenue bond financing arrangements. The plaintiffs then
filed a petition for review with the California State Supreme Court, and, on
April 2, 1997, the Court granted the plaintiff's petition for review. A decision
from the Supreme Court is expected to be decided within the 1998 calendar year.
CONSTITUTIONAL, LEGISLATIVE AND OTHER FACTORS.
Certain California constitutional amendments, legislative
measures, executive orders, administrative regulations and voter initiatives
could produce the adverse effects described below, among others.
REVENUE DISTRIBUTION. Certain Debt Obligations in the
California Municipal Bond 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.
HEALTH CARE LEGISLATION. Certain Debt Obligations in the
California Municipal Bond 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 Debt
Obligations.
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 other factors. Other reductions or limitations
may be imposed on payment for services rendered to MediCal beneficiaries in the
future.
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Under this approach, in most geographical areas of California,
only those hospitals which enter into a MediCal 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 Debt Obligations 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 Debt Obligations, 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. 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.
MORTGAGES AND DEEDS. Certain Debt Obligations in the
California Municipal Bond 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 statutes 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
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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 judgment 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. The debtor may
reinstate the mortgage, in the manner described above, up to five business days
prior to the scheduled sale date. 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.
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 Debt Obligations in the California Municipal Bond 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 then only
if the borrower prepays an amount in excess of 20% of the original principal
amount of the mortgage loan in a 12-month period; a prepayment charge cannot in
any event exceed six months' advance interest on the amount prepaid during the
12-month period in excess of 20% of the original principal amount of the 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.
PROPOSITION 13. Certain of the Debt Obligations 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 was to
limit ad valorem taxes on real property and to restrict the ability of taxing
entities to increase real property tax revenues.
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Section 1 of Article XIIIA, as amended, limits the maximum ad
valorem tax on real property to 1% of full cash value to be collected by the
counties and apportioned according to law. The 1% limitation does not apply to
ad valorem taxes or special assessments to pay the interest and redemption
charges on any bonded indebtedness for the acquisition or improvement of real
property approved 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.
Legislation enacted by the California Legislature to implement
Article XIIIA 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.
PROPOSITION 9. On November 6, 1979, an initiative known as
"Proposition 9" 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.
PROPOSITION 98. On November 8, 1988, voters of the State
approved Proposition 98, a combined initiative constitutional amendment and
statute called the "Classroom Instructional Improvement and Accountability Act."
Proposition 98 changed State funding of public education below the university
level and the operation of the State Appropriations Limit, primarily by
guaranteeing K-14 schools a minimum share of General Fund revenues. Under
Proposition 98 (modified by Proposition 111 as discussed below), K-14 schools
are guaranteed the greater of (a) in general, a fixed percent of General Fund
revenues ("Test 1"), (b) the amount appropriated to K-14 schools in the prior
year, adjusted for changes in the cost of living (measured as in Article XIII B
by reference to State per capita personal income) and enrollment ("Test 2"), or
(c) a third test, which would replace Test 2 in any year when the percentage
growth in per capita General Fund revenues from the prior year plus one half of
one percent is less than the percentage growth in State per capita personal
income ("Test 3"). Under Test 3, schools would receive the amount appropriated
in the prior year adjusted for changes in enrollment and per capita General Fund
revenues, plus an additional small adjustment factor. If Test 3 is used in any
year, the difference between Test 3 and Test 2 would become a "credit" to
schools which would be the basis of payments in future years when per capita
General Fund revenue growth exceeds per capita personal income growth.
Proposition 98 permits the Legislature -- by two-thirds vote
of both houses, with the Governor's concurrence -- to suspend the K-14 schools'
minimum funding formula for a one-year period. Proposition 98
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also contains provisions transferring certain State tax revenues in excess of
the Article XIII B limit to K-14 schools.
During the recession years of the early 1990s, General Fund
revenues for several years were less than originally projected, so that the
original Proposition 98 appropriations turned out to be higher than the minimum
percentage provided in the law. The Legislature responded to these developments
by designating the "extra" Proposition 98 payments in one year as a "loan" from
future years' Proposition 98 entitlements, and also intended that the "extra"
payments would not be included in the Proposition 98 "base" for calculating
future years' entitlements. In 1992, a lawsuit was filed, California Teachers'
Association v. Gould, which challenged the validity of these off-budget loans.
During the course of this litigation, a trial court determined that almost $2
billion in "loans" which had been provided to school districts during the
recession violated the constitutional protection of support for public
education. A settlement was reached on April 12, 1996 which ensures that future
school funding will not be in jeopardy over repayment of these so-called loans.
PROPOSITION 111. 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
recalculated spending limits for the State and for local governments, allowed
greater annual increases in the limits, allowed the averaging of two years' tax
revenues before requiring action regarding excess tax revenues, reduced 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), removed 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, limited the amount of State tax revenue
over the limit which would be transferred to school districts and community
college districts, and exempted increased gasoline taxes and truck weight fees
from the State appropriations limit. Additionally, Proposition 111 exempted from
the State appropriations limit funding for capital outlays.
PROPOSITION 62. On November 4, 1986, California voters
approved an initiative statute known as Proposition 62. This initiative provided
the following:
1. 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;
2. 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;
3. Restricts the use of revenues from a special tax to the
purposes or for the service for which the special tax was imposed;
4. Prohibits the imposition of ad valorem taxes on real
property by local governmental entities except as permitted by Article XIIIA;
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5. Prohibits the imposition of transaction taxes and sales
taxes on the sale of real property by local governments;
6. 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;
7. Requires that, in the event a local government fails to
comply with the provisions of this measure, a 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
8. 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
impossible 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. The
California Court of Appeal in City of Woodlake v. Logan, (1991) 230 Cal.App.3d
1058, subsequently held that Proposition 62's popular vote requirements for
future local taxes also provided for an unconstitutional referenda. The
California Supreme Court declined to review both the City of Westminster and the
City of Woodlake decisions.
In Santa Clara Local Transportation Authority v. Guardino,
(Sept. 28, 1995) 11 Cal.4th 220, reh'g denied, modified (Dec. 14, 1995) 12
Cal.4th 344e, the California Supreme Court upheld the constitutionality of
Proposition 62's popular vote requirements for future taxes, and specifically
disapproved of the City of Woodlake decision as erroneous. The Court did not
determine the correctness of the City of Westminster decision, because that case
appeared distinguishable, was not relied on by the parties in Guardino, and
involved taxes not likely to still be at issue. It is impossible to predict the
impact of the Supreme Court's decision on charter cities or on taxes imposed in
reliance on the City of Woodlake case.
Senate Bill 1590 (O'Connell), introduced February 16, 1996,
would make the Guardino decision inapplicable to any tax first imposed or
increased by an ordinance or resolution adopted before December 14, 1995. The
California State Senate passed the Bill on May 16, 1996 and it is currently
pending in the California State Assembly. It is not clear whether the Bill, if
enacted, would be constitutional as a non-voted amendment to Proposition 62 or
as a non-voted change to Proposition 62's operative date.
PROPOSITION 218. On November 5, 1996,the voters of the State
approved Proposition 218, a constitutional initiative, entitled the "Right to
Vote on Taxes Act" ("Proposition 218"). Proposition 218 adds Articles XIII C and
XIII D to the California Constitution and contains a number of interrelated
provisions affecting the ability of local governments to levy and collect both
existing and future taxes, assessments, fees and charges. Proposition 218 became
effective on November 6, 1996. The Sponsors are unable to predict whether and to
what extent Proposition 218 may be held to be constitutional or how its terms
will be interpreted and applied by the courts. However, if upheld, Proposition
218 could substantially restrict certain local
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governments' ability to raise future revenues and could subject certain existing
sources of revenue to reduction or repeal, and increase local government costs
to hold elections, calculate fees and assessments, notify the public and defend
local government fees and assessments in court.
Article XIII C of Proposition 218 requires majority voter
approval for the imposition, extension or increase of general taxes and
two-thirds voter approval for the imposition, extension or increase of special
taxes, including special taxes deposited into a local government's general fund.
Proposition 218 also provides that any general tax imposed, extended or
increased without voter approval by any local government on or after January 1,
1995 and prior to November 6, 1996 shall continue to be imposed only if approved
by a majority vote in an election held within two years of November 6, 1996.
Article XIII C of Proposition 218 also expressly extends the
initiative power to give voters the power to reduce or repeal local taxes,
assessments, fees and charges, regardless of the date such taxes, assessments,
fees or charges were imposed. This extension of the initiative power to some
extent constitutionalizes the March 6, 1995 State Supreme Court decision in
Rossi v. Brown, which upheld an initiative that repealed a local tax and held
that the State constitution does not preclude the repeal, including the
prospective repeal, of a tax ordinance by an initiative, as contrasted with the
State constitutional prohibition on referendum powers regarding statutes and
ordinances which impose a tax. Generally, the initiative process enables
California voters to enact legislation upon obtaining requisite voter approval
at a general election. Proposition 218 extends the authority stated in Rossi v.
Brown by expanding the initiative power to include reducing or repealing
assessments, fees and charges, which had previously been considered
administrative rather than legislative matters and therefore beyond the
initiative power.
The initiative power granted under Article XIII C of
Proposition 218, by its terms, applies to all local taxes, assessments, fees and
charges and is not limited to local taxes, assessments, fees and charges that
are property related.
Article XIII D of Proposition 218 adds several new
requirements making it generally more difficult for local agencies to levy and
maintain "assessments" for municipal services and programs. "Assessment" is
defined to mean any levy or charge upon real property for a special benefit
conferred upon the real property.
Article XIII D of Proposition 218 also adds several provisions
affecting "fees" and "charges" which are defined as "any levy other than an ad
valorem tax, a special tax, or an assessment, imposed by a local government upon
a parcel or upon a person as an incident of property ownership, including a user
fee or charge for a property related service." All new and, after June 30, 1997,
existing property related fees and charges must conform to requirements
prohibiting, among other things, fees and charges which (i) generate revenues
exceeding the funds required to provide the property related service, (ii) are
used for any purpose other than those for which the fees and charges are
imposed, (iii) are for a service not actually used by, or immediately available
to, the owner of the property in question, or (iv) are used for general
governmental services, including police, fire or library services, where the
service is available to the public at large in substantially the same manner as
it is to property owners. Further, before any property related fee or charge may
be imposed or increased, written notice must be given to the record owner of
each parcel of land affected by such fee or charges. The local government must
then hold a hearing upon the proposed imposition or increase of such property
based fee, and if written protests against the proposal are presented by a
majority of the owners of the identified parcels, the local government may not
impose or increase the fee or charge. Moreover, except for
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<PAGE> 39
fees or charges for sewer, water and refuse collection services, no property
related fee or charge may be imposed or increased without majority approval by
the property owners subject to the fee or charge or, at the option of the local
agency, two-thirds voter approval by the electorate residing in the affected
area.
PROPOSITION 87. 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.
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 Municipal 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 35% 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 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 Pacific Horizon'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 Bond Fund 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
A Fund's or Master Portfolio's investment objectives are
non-fundamental and may be changed without a vote of shareholders. The
prospectus for each Fund or Master Portfolio summarizes certain fundamental
policies that may not be changed with respect to a Fund or Master Portfolio
without the affirmative vote of the holders of the majority of the Fund's or
Master Portfolio's outstanding shares (as defined below under "Additional
Information - Miscellaneous"). Similarly, the following enumerated additional
fundamental policies may not be changed with respect to each Fund or Master
Portfolio or without such a vote of shareholders.
Each Fund of the Company or Master Portfolio of Master Trust
may not:
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<PAGE> 40
1. Underwrite any issue of securities within the meaning of
the Securities Act of 1933 (the "1933 Act") except when it might technically be
deemed to be an underwriter either (a) in connection with the disposition of a
portfolio security, or (b) in connection with the purchase of securities
directly from the issuer thereof in accordance with its investment objective.
2. Purchase or sell real estate, except a Fund may purchase
securities of issuers which deal or invest in real estate and may purchase
securities which are secured by real estate or interests in real estate.
3. Purchase or sell commodities, except that a Fund may to the
extent consistent with its investment objective, invest in securities of
companies that purchase or sell commodities or which invest in such programs,
and purchase and sell options, forward contracts, futures contracts, and options
on futures contracts. This limitation does not apply to foreign currency
transactions including without limitation forward currency contracts.
4. Purchase any securities which would cause 25% or more of
the value of its 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, any state or territory
of the United States, or any of their agencies, instrumentalities or political
subdivisions, and (b) notwithstanding this limitation or any other fundamental
investment limitation, assets may be invested in the securities of one or more
diversified management investment companies to the extent permitted by the 1940
Act and the rules and regulations thereunder.
5. Make loans, except to the extent permitted by the 1940 Act.
6. Borrow money, issue senior securities or mortgage, pledge
or hypothecate its assets except to the extent permitted under the 1940 Act.
7. Purchase securities (except securities issued or guaranteed
by the U.S. Government, its agencies or instrumentalities) of any one issuer if,
as a result, more than 5% of its total assets will be invested in the securities
of such issuer or it would own more than 10% of the voting securities of such
issuer, except that (a) up to 25% of its total assets may be invested without
regard to these limitations and (b) a Fund's assets may be invested in the
securities of one or more diversified management investment companies to the
extent permitted by the 1940 Act.
In addition, each Fund or Master Portfolio is subject to the
following non-fundamental policies and limitations, which may be changed without
the vote of shareholders:
Each Fund of the Company and Portfolio of the Master Trust may
not:
1. Sell securities short, maintain a short position, or
purchase securities on margin, except for such short-term credits as are
necessary for the clearance of transactions. For this purpose, a deposit or
payment by a Fund for initial or maintenance margin in connection with futures
contracts is not considered to be the purchase or sale of a security on margin.
2. Purchase securities of other investment companies except as
permitted by the 1940 Act.
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<PAGE> 41
The National Municipal Bond Fund, Aggressive Growth Fund and
California Municipal Bond Fund may not:
1. Purchase securities of companies for the purpose of
exercising control.
The National Municipal Bond Fund, International Equity Fund,
Flexible Income Fund, Intermediate Bond Master Portfolio, Blue Chip Master
Portfolio, Asset Allocation Fund, U.S. Government Securities Fund, Capital
Income Fund and California Municipal Bond Fund may not:
1. Write or sell puts, calls, straddles, spreads or
combinations thereof except that a Fund may acquire standby commitments and may
enter into futures contracts and options in accordance with their investment
objectives.
***
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.
***
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. The net asset value of each of the Feeder Funds is equal to
such Fund's pro rata share of the total investments and other assets of its
corresponding Master Portfolio, less any liabilities with respect to such Feeder
Fund, including each Feeder Fund's pro rata share of the Master Portfolio's
liabilities.
VALUATION OF THE 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 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
with remaining maturities of sixty 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 and thereafter assuming a constant
amortization to maturity of the difference between the principal amount due at
maturity and cost.
VALUATION OF THE CALIFORNIA MUNICIPAL BOND FUND AND THE NATIONAL MUNICIPAL BOND
FUND
The California Municipal Bond Fund's and National Municipal
Bond Fund's assets are valued for purposes of pricing sales and redemptions by
an independent pricing service (the "Service") approved by the Board. 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
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<PAGE> 42
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
California Municipal Bond 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 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 Company assumes a constant amortization to maturity of
the difference between the principal amount due at maturity and cost.
VALUATION OF CAPITAL INCOME FUND, U.S. GOVERNMENT SECURITIES FUND, SHORT-TERM
GOVERNMENT FUND, INTERNATIONAL EQUITY FUND, ASSET ALLOCATION FUND AND FLEXIBLE
INCOME 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. 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 particular Board. 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 particular Board. Valuation of options is
described above under "Investment Objectives and Policies - Options Trading."
VALUATION OF THE INTERMEDIATE BOND AND BLUE CHIP MASTER PORTFOLIOS
Except for debt securities held by the Intermediate Bond and
Blue Chip Master 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
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
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<PAGE> 43
Trustees of 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 Intermediate Bond and Blue Chip
Master 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 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 represents fair value.
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 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 Master Trust.
SUPPLEMENTARY PURCHASE INFORMATION - A SHARES
For the purpose of applying the Right of Accumulation or
Letter of Intent privileges available to certain shareholders as 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
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<PAGE> 44
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 a Fund's
Exchange Privilege.
The computation of the hypothetical offering price per share
of A Shares for each Fund based on the value of the California Municipal Bond,
Aggressive Growth, U.S. Government Securities, Capital Income, Intermediate
Bond, Blue Chip, Asset Allocation, Flexible Income, National Municipal Bond,
Short-Term Government and International Equity Funds' net assets on February 28,
1998, and each Fund's A Shares outstanding on such date is as follows:
<TABLE>
<CAPTION>
U.S.
California Aggressive Government Capital Intermediate Blue Chip Fund
Municipal Growth Fund Securities Income Fund Bond Fund
Bond Fund Fund
--------- ----
<S> <C> <C> <C> <C> <C> <C>
Net Assets $213,984,976 $218,607,479 $71,101,297 $391,142,965 $41,874,875 $288,256,185
Outstanding
Securities 28,026,050 9,654,371 7,465,492 22,641,045 4,322,374 9,640,840
Net Asset
Value Per
Share $7.64 $22.64 $9.52 $17.28 $9.69 $29.90
Sales
Charge, 4.50
percent of
offering
price (4.71
percent of
net asset
value per
share) $0.36 $1.07 $0.45 $0.81 $0.46 $1.41
Maximum
Offering
Price to
Public $8.00 $23.71 $9.97 $18.09 $10.15 $31.31
</TABLE>
<TABLE>
<CAPTION>
Asset Flexible National Short-Term International
Allocation Income Fund Municipal Bond Government Equity Fund
Fund Fund Fund
---- ---- ----
<S> <C> <C> <C> <C> <C>
Net Assets $49,239,679 $37,105,146 $14,262,911 $32,685,244 $41,642,883
Outstanding
Securities 2,299,985 2,259,885 1,355,717 3,259,919 3,947,858
Net Asset
Value Per
Share $21.41 $16.42 $10.52 $10.03 $10.55
Sales
Charge, 4.50
percent of
offering
price (4.71
percent of
net asset
value per
share) $1.01 $0.77 $0.50 $0.47 $0.50
Maximum
Offering
Price to
Public $22.42 $17.19 $11.02 $10.50 $11.05
</TABLE>
SUPPLEMENTARY REDEMPTION INFORMATION: A, B AND K SHARES
A, B and K Shares in the Capital Income Fund, U.S. Government
Securities Fund, California Municipal Bond Fund, Intermediate Bond Fund, Blue
Chip Fund, Asset Allocation Fund, Flexible Income Fund, International Equity
Fund, Short- Term Government Fund (A and B Shares Only) and National Municipal
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 on B Shares) 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
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<PAGE> 45
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 on B Shares) will normally
be wired in federal funds on the next business day thereafter. Redemption
proceeds (less any applicable contingent deferred sales charge on B Shares) 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 8968, Wilmington, Delaware 19899-8968. 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.
A, B and K Share investors in the U.S. Government Securities
Fund, California Municipal Bond Fund, Flexible Income Fund and National
Municipal 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, PFPC, P.O. Box 8968, Wilmington, Delaware 19899-8968, 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 Funds' Prospectuses. After
clearance, Checks will be returned to the investor.
Because dividends on the U.S. Government Securities Fund,
California Municipal Bond Fund, Flexible Income Fund and National Municipal Bond
Fund are declared 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, both A and B
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.") K Shares may only be
purchased by: (a) businesses or other organizations that participate in the
Daily Advantage(R) Program sponsored by Bank of America; (b) individuals
investing proceeds from a redemption of shares from another open-end investment
company on which such individual paid a front-end sales load if (i) such
redemption occurred within 30 days prior to the purchase order, and (ii) such
other open-end investment company was not distributed and advised by PDI and
Bank of America, respectively, or their affiliates; (c) accounts opened for IRA
rollovers from a 401(k) plan in which the assets were held in any Pacific
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<PAGE> 46
Horizon or Time Horizon Fund and subsequent purchases into an IRA rollover
account opened as described above, so long as the original IRA rollover account
remains open; (d) accounts under Section 403(b)(7) of the Code, (e) deferred
compensation plans under Section 457 of the Code and (f) certain other
retirement plans. Bank of America and Service Organizations may impose minimum
customer account and other requirements in addition to those imposed by the
Funds and described in the respective Prospectuses. Purchase orders will be
effected only on business days. SRF Shares of the Funds are available for the
investment of retirement funds held in Eligible Retirement Accounts as described
in the SRF Share Prospectus.
A Shares in each Fund are sold with a sales load, except for
such exemptions as noted in the Prospectuses. The exemptions to the imposition
of a sales load on A Shares are due to the nature of the investors and/or the
reduced sales efforts that will be necessary in obtaining such investments. A
Shares are also subject to a shareholder servicing fee. B Shares are sold
without a front-end sales load, but are subject to a contingent deferred sales
charge and an ongoing distribution and shareholder servicing fee. K Shares are
offered at net asset value with neither a front-end sales charge, nor a
contingent deferred sales charge. K Shares are subject to a distribution plan
fee and an administrative and shareholder services fee. SRF Shares in each Fund
are sold without a sales load. SRF Shares are subject to Shareholder Servicing
fees. 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 or organizations 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 A, B or K 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. B Shares
liquidated by the Transfer Agent as fees for custodial services to IRA accounts
will not be subject to the contingent deferred sales charge. 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> 47
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.
All or a portion of the SRF Shares held in a Fund can be
redeemed (sold) at any time. The redemption price will be the net asset value
per share next determined following receipt by the Company of a shareholder's
satisfactorily completed instructions. The value of an SRF Share upon redemption
may be more or less than the value when purchased, depending upon the net asset
value of an SRF Share of the Fund at the time of the redemption. Redemptions are
subject to determination by the Company that the investment instruction form or
the redemption request and other distribution documents, if any, are complete.
Payment for SRF Shares redeemed will normally be made to the
custodian of the shareholder within one business day of receipt by the Company
of redemption instructions, but in no event will payment be made more than seven
days after receipt of redemption instructions except in the circumstances
described below.
Exchange Privileges for A, B and K Shares. Shareholders in the
Pacific Horizon Family of Funds have an exchange privilege whereby they may
exchange all or part of their shares for like shares of another investment
portfolio in the Pacific Horizon Family of Funds or for like shares of an
investment portfolio of Time Horizon Funds. In addition, shareholders of the
Funds may exchange B Shares for Pacific Horizon Shares of the Pacific Horizon
Prime Fund without the payment of any contingent deferred sales charge at the
time the exchange is made. 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, D, E, F
and G below will be made on the basis of the relative net asset values per share
of the investment portfolios involved in the transaction.
A. 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 other A
Shares of any other investment portfolio in the Pacific Horizon Family of Funds
or for like shares of the Time Horizon Funds.
B. B Shares acquired pursuant to an exchange transaction will continue
to be subject to a contingent deferred sales charge. However, B Shares that have
been acquired through an exchange of B Shares may be exchanged for other B
Shares or for like shares of Time Horizon Funds without the payment of a
contingent deferred sales charge at the time of exchange. Except as noted in C
below, in determining the holding period for calculating the contingent deferred
sales charge payable on redemption of B Shares, the holding period of the shares
originally held will be added to the holding period of the shares acquired
through exchange.
-47-
<PAGE> 48
C. B Shares may be exchanged for Y Shares of the Pacific Horizon Prime
Fund ("Prime Shares") without paying a contingent deferred sales charge. At the
time of such an exchange, a shareholder's holding period for calculating the
contingent deferred sales charge payable on redemption of B Shares of a Fund
will cease to accumulate. If the shareholder subsequently exchanges the shares
back into B Shares of a Fund, the holding period accumulation on the shares will
resume as of the time when the exchange was made into the Prime Shares. In the
event that a shareholder wishes to redeem Prime Shares acquired by exchange for
B Shares of a Fund, the contingent deferred sales charge applicable to the
accumulated B Shares of a Fund holding period prior to the exchange into the
Prime Shares will be charged.
D. A or B Shares of any investment portfolio in the Pacific Horizon
Family of Funds or like shares of 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. A Shares purchased with a sales load or issued in
connection with an exchange transaction involving A 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 A or B Shares, as the case
may be, of any other investment portfolio within 120 days of your redemption
trade date. 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.
E. A 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 Pacific Horizon Family of Funds that is offered
without a sales load.
F. A 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 A Shares in any other portfolio in the Pacific Horizon Family of Funds.
G. K Shares of any investment portfolio in the Pacific Horizon Family
of Funds may be exchanged without a sales load for other K Shares of any other
investment portfolio in the Pacific Horizon Family of Funds or for like shares
of the Time Horizon Funds.
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 A
Shares of another investment portfolio in the Pacific Horizon Family or for like
shares of 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.
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<PAGE> 49
Exchange Privileges for Eligible Retirement Accounts. SRF
Shares held in any Fund may be exchanged for SRF Shares of any other Fund. SRF
Shares held in any Fund may also be exchanged for A Shares in any other taxable,
non-money market Fund offered by the Company or a Time Horizon Fund without
incurring the front-end sales charge otherwise applicable on sales of A Shares
("Eligible Exchange Shares"). SRF Shares or Eligible Exchange Shares may be
exchanged for Pacific Horizon Shares of the Pacific Horizon Prime Fund. Eligible
Exchange Shares may be further exchanged for A Shares in any taxable, non- money
market fund offered by the Company or a Time Horizon Fund without incurring the
front-end sales charges otherwise applicable, or for SRF Shares offered by a
Fund. SRF Shares or Eligible Exchange Shares held in an IRA account for which a
Participant's surviving spouse is the beneficiary may continue to be exchanged
for SRF Shares or A Shares as described above. 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.
The following transactions are examples of transactions that
will interrupt the maintenance of Eligible Retirement Account status for a
Participant's account and will terminate the account's ability to engage in the
exchange privileges described above:
1. SRF Shares or Eligible Exchange Shares held in an Eligible Pension
or Profit Sharing Trust or a SEP IRA, which are transferred by the Participant
into a personal rollover IRA, will no longer be eligible to exchange such shares
for A Shares without incurring the front-end sales load applicable to A Shares;
2. SRF Shares or Eligible Exchange Shares held in an IRA account for
which a Participant's surviving beneficiary upon transfer out of the decedent's
account is other than the Participant's spouse will no longer be eligible to
exchange such shares for A Shares without incurring the front-end sales load
applicable to A Shares; and
3. SRF Shares or Eligible Exchange Shares which are liquidated in their
entirety by the Participant into a Certificate of Deposit will no longer be
eligible to exchange such shares for A Shares without incurring the front-end
sales load applicable to A Shares.
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 is a day on which the New York
Stock Exchange is open for trading. In 1998, the holidays on which the New York
Stock Exchange is closed are: New Year's Day, Dr. Martin Luther King, Jr. 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
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<PAGE> 50
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 contingent
deferred sales charge with respect to B Shares is not charged on involuntary
redemptions. 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.
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 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 Municipal Bond Fund and the
National Municipal 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, including dividends, interest, and
net short-term capital gains (the excess of net short-term capital gain over net
long-term capital loss, if any), subject to certain adjustments and excluding
the excess of net long-term capital gain for the taxable year over the net
short-term capital loss for such year, if any. Each 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.
Any distribution of the excess of net long-term capital gain
over net short-term capital loss is taxable to shareholders as long-term capital
gain, regardless of how long the shareholder has held Fund shares
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<PAGE> 51
and whether such gain is 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 those shares.
Ordinary income of individuals is taxable at a maximum
marginal 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 gain is 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%.
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 net capital
gain over net capital loss). 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 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 that they are not subject to backup withholding or
that they are "exempt recipients."
At February 28, 1998, the U.S. Government Securities Fund had
capital loss carryovers of $9,126,726 of which $7,462,810, will expire in fiscal
2003 and $1,663,916 will expire in fiscal 2005; and the Flexible Income Fund had
capital loss carryovers of $6,284,642 of which $5,401,993 and $882,649 will
expire in fiscal 1999 and 2003, respectively. To the extent provided by the
regulations of the Code, these capital loss carryovers will be used to offset
future net realized gains on securities transactions. As such, it is probable
that the gains so offset will not be distributed to shareholders.
FEDERAL - CALIFORNIA MUNICIPAL BOND FUND AND NATIONAL MUNICIPAL BOND FUND
The California Municipal Bond Fund's and National Municipal
Bond 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 a Fund and designated as an
exempt-interest dividend in a written notice mailed to shareholders after the
close of such Fund's taxable year. However, the aggregate amount of dividends so
designated by a Fund cannot exceed the excess of the amount of interest exempt
from tax under Section 103 of the Code received by such Fund during its 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 particular Fund for such year. In order for a 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 such Fund's
assets must consist of exempt-interest obligations.
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<PAGE> 52
Exempt-interest dividends may be treated by shareholders of
the Funds 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 Funds. 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, 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.
A percentage of the interest on indebtedness incurred by a
shareholder to purchase or carry shares, equal to the percentage of the total
non-capital gain dividends distributed during the shareholder's taxable year
that are exempt-interest dividends, 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 Municipal
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 applicable to individuals and corporations 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 MUNICIPAL BOND FUND
As a regulated investment company, the California Municipal
Bond Fund (the "Fund") will be relieved of liability for 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
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<PAGE> 53
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 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 Municipal 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
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<PAGE> 54
respect to the application of such taxes to the receipt of Fund dividends and as
to their own California state tax situation, in general.
TAXATION OF THE MASTER PORTFOLIOS
Management of the Master Portfolios corresponding to each of
the Feeder Funds intends for each Master Portfolio to be treated as a
partnership (or, in the event that a Feeder Fund is the sole investor in a
Master 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 of nominee) under the Code, any interest, dividends,
gains and losses of the Master Portfolios will be deemed to have been reported
as income/loss (i.e., "passed through") to their investors, regardless of
whether any amounts are actually distributed by the Master Portfolios.
Each investor in a Master Portfolio will be taxed on its share
(as determined in accordance with the governing instruments of the particular
Master Portfolio) of the Master 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 Master Portfolio's assets, income and distributions will be
managed in such a way that an investor in a Master 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 Master 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.
Except as noted above with respect to California state
personal income taxation of dividends paid by the California Municipal 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
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<PAGE> 55
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>
William P. Carmichael 53 Director Senior Vice President, Sara Lee
808 S. Garfield Corporation (1991 to 1993); Treasurer,
Hinsdale, IL 60521 Senior Vice President and Chief Financial
Officer, Beatrice Company (1987 to
1990); Trustee, Time Horizon Fund
(registered investment company) (since
1995) Trustee, Pacific Innovations Trust
(since 1997) (registered investment
company); Trustee, 231 Funds (1993 to
1995) (registered investment company).
Edward S. Bottum 63 Director Managing Director, Chase Franklin
C/o Chase Franklin Corporation Corporation (venture capital firm) (since
100 S. Wacker Drive 1990); Trustee, Time Horizon Funds (since
Suite 1140 1995); Trustee and Chairman, Pacific
Chicago, IL 60606 Innovations Trust (since 1997) (registered
investment company ); formerly Vice
Chairman of Continental Bank N.A. (retired
1990); formerly Trustee, 231 Funds
(February 1993 to August 1995).
Robert E. Greeley 66 Director Chairman, Page Mill Asset Management (a
Page Mill Asset Management private investment company) (since 1987);
433 California Street Manager, Morgan Grenfell Small Cap Fund
Suite 900 (since 1986); Trustee, Master Investment
San Francisco, CA 94104 Trust Series I (registered investment
company) (since 1993), former Trustee,
Master Investment Trust, Series II
(registered investment company) (1993-
1997), Trustee, Time Horizon Funds
(registered investment company) (since
1995); Trustee and President, Pacific
Innovations Trust (since 1996)
(registered investment
</TABLE>
-55-
<PAGE> 56
<TABLE>
<CAPTION>
Position with
Name and Address Age Company Principal Occupations
- ---------------- --- ------- ---------------------
<S> <C> <C> <C>
company); formerly Director, Bunker Hill
Income Securities, Inc. (from 1989 to
1994); Trustee, SunAmerica Fund Group
(previously Equitec Siebel Fund Group)
(registered investment companies) (from
1984 to 1992); formerly Director,
Manager, Corporate Investments, Hewlett
Packard Company (from 1979 to 1991).
Thomas M. Collins; 63 Director Of counsel, law firm of McDermott &
225 S. Lake Avenue Trayner; Partner of the law firm of
Suite 410 Musick, Peeler &Garrett (until April,
Pasadena, CA 91101-3005 1993); Chairman of the Board and Trustee,
Master Investment Trust, Series I
(registered investment company) (since
1993); President and Chairman of the
Board of Pacific Horizon Funds, Inc.
(1982 to August 31, 1995); Member, Fund
Directions Advisory Board (since July
1993); former Chairman of the Board and
Trustee, Master Investment Trust, Series
II (registered investment company) 1993
to April 1997; former Director, Bunker
Hill Income Securities, Inc. (registered
investment company) through 1991.
Douglas B. Fletcher 73 Vice Chairman of Chairman of the Board and Chief Executive
Fletcher Capital Advisors the Board Officer, Fletcher Capital Advisors,
Incorporated Incorporated, (registered investment
4 Upper Newport Plaza advisor) 1991 to date; Director, FCA
Suite 100, Securities, Inc. (registered
Newport Beach, CA 92660-2629 broker/dealer) 1996 to date; Partner,
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
</TABLE>
-56-
<PAGE> 57
<TABLE>
<CAPTION>
Position with
Name and Address Age Company Principal Occupations
- ---------------- --- ------- ---------------------
<S> <C> <C> <C>
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; Chairman, TIS
Mortgage Investment Company (real estate
investment trust) (since 1988); Trustee
and a former Vice Chairman of the Board,
Claremont McKenna College; Chartered
Financial Analyst.
Cornelius J. Pings* 69 Chairman of the President, Association of American
480 S. Orange Grove Blvd. Board and Universities, (February 1993 to June 1998);
#6 President Provost (from 1982 to January 1993) and
Pasadena, CA 91105 Senior Vice President for Academic Affairs
(from 1981 to January 1993), University of
Southern California; Trustee, Master
Investment Trust, Series I (since 1995);
former Trustee, Master Investment Trust,
Series II (from 1995 to 1997); Director,
Farmers Group, Inc. (insurance company)
(since 1991).
Stephen M. Wynne 41 Vice President Executive Vice President and Chief
Executive Vice President, Accounting Officer (since 1993) and Senior
PFPC Inc. Vice President and Chief Accounting
400 Bellevue Parkway Officer (1991 to 1993), PFPC Inc.;
Wilmington, DE 19809 Executive Vice President, PFPC
International (since 1995); Vice President
and Chief Accounting Officer, PNC
Institutional Management Corp. (since 1987).
</TABLE>
- ----------
* Dr. Pings is an "interested director" of the Company as defined in the
1940 Act.
-57-
<PAGE> 58
<TABLE>
<CAPTION>
Position with
Name and Address Age Company Principal Occupations
- ---------------- --- ------- ---------------------
<S> <C> <C> <C>
Jay F. Nusblatt 36 Treasurer Vice President and Director of Fund
Vice President, PFPC Inc. Accounting and Administration, PFPC Inc.
103 Bellevue Parkway (since 1993); formerly Assistant Vice
Wilmington, DE 19809 President, Fund/Plan Services, Inc. (1989 to 1993).
W. Bruce McConnel, III 54 Secretary Partner of the law firm of Drinker
1345 Chestnut Street Biddle & Reath LLP.
Philadelphia National Bank Building,
Suite 1100
Philadelphia, PA 19107
Gary M. Gardner 46 Assistant Chief Counsel-Mutual Funds, PNC Bank
Chief Counsel-Mutual Funds, Secretary (since 1994); Associate General Counsel,
PNC Bank The Boston Company, Inc. (1992 to 1994);
1600 Market Street, General Counsel, SunAmerica Asset
28th Fl. Management Inc. (1986 to 1992).
Philadelphia, PA 19103.
J. Robert Dugan 32 Assistant Counsel-Mutual Funds, PNC Bank (since
Counsel-Mutual Funds, Secretary 1993); Associate, Drinker Biddle & Reath
PNC Bank LLP (1990 to 1993).
1600 Market Street
28th Fl.
Philadelphia, PA 19103
</TABLE>
- ----------
* "Interested Person" as defined in the Investment Company Act of 1940.
Mr. Pings is an "interested" person solely by reason of his position as
President of the Company.
The Board has an audit committee, contract review committee,
nominating committee and a valuation committee. The audit committee is
responsible for reviewing the results of the audit of the Company by its
independent public accountant. The contract review committee is responsible for
reviewing the performance of the Company's service providers in connection with
the renewal of the Company's service contracts. The nominating committee is
responsible for reviewing the credentials of proposed nominees for the Company's
Board and for selecting and nominating those directors who are not "interested
persons" (as defined in the 1940 Act) of the Company. The valuation committee is
responsible for handling issues arising out of the pricing of securities.
Each director is entitled to receive an annual fee of $60,000
plus $1,000 for each day that a director participates in all or a part of a
Board meeting; the Chairman of the Board receives an additional $40,000 per
annum; each member of a Committee of the Board is entitled to receive
-58-
<PAGE> 59
$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. Each Director is also reimbursed for out-of-pocket
expenses incurred as a Director. 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, 1998, the Company paid
or accrued for the account of its directors as a group for services in all
capacities a total of $393,644. Of that amount, $3,358, $3,250, $1,131, $5,020,
$999, $12,968, $11,226, $5,207, $317, $374 and $6,138 of directors' compensation
were allocated to the Aggressive Growth, California Municipal Bond, U.S.
Government Securities, Capital Income, Intermediate Bond, Blue Chip, Asset
Allocation, Flexible Income, Short-Term Government, International Equity and
National Municipal Bond Funds, respectively. Each director is also reimbursed
for out-of-pocket expenses incurred as a director. Drinker Biddle & Reath LLP,
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 the retirement plan approved by the Board of Directors,
including a majority of its Directors who are not "interested persons" of the
Company, a Director in office for the entire period from February 28, 1994 to
March 18, 1998 who dies or resigns is entitled to receive ten annual payments
each equal to the greater of (i) the "Applicable Percentage" set forth below of
the annual Director's retainer that was payable by the Company during the year
of his/her death or resignation, or (ii) the Applicable Percentage of the annual
Director's retainer then in effect for Directors of the Company during the year
of such payment:
Years of Service
after February 28, 1994 Applicable Percentage*
----------------------- ----------------------
Fewer than 5 0**
5 but fewer than 6 50
6 but fewer than 7 60
7 but fewer than 8 70
8 but fewer than 9 80
9 but fewer than 10 90
10 or more 100
- ----------
* For service that includes a fractional year, a Director's years of service is
rounded to the nearest quarter of a year of service, and the Director's
Applicable Percentage is rounded to the nearest 0.25%.
** A Director who either resigns in good standing or dies before completing five
years of service as a director is assigned an Applicable Percentage of 50
percent.
Such Director is also entitled to receive an additional
retirement benefit following his death or resignation equal to an additional
percentage of the annual Director's retainer described above in this paragraph.
The additional percentage equals one-half of the difference between 100 percent
and the Director's Applicable Percentage. The Director's additional retirement
benefit is paid at the same time and in the same manner as the
-59-
<PAGE> 60
regular retirement benefit. 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
served as Chairman of the Board since the Company's inception in 1982. The
retirement benefit 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 to be paid by the Company within 45 days
of the death or resignation of the Director. The present value of such benefits
shall 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.
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.
TRUSTEES AND OFFICERS OF MASTER INVESTMENT TRUST, SERIES I
The trustees and officers of Master Trust, their addresses,
age, 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; 63 Chairman of the See "Directors and Officers of the
225 S. Lake Avenue Board Company."
Suite 410
Pasadena, CA 91101-3005
Michael Austin 62 Trustee of Master Chartered Accountant; Trustee, Master
Victory House, Nelson Quay Trust Investment Trust, Series II (1993 to
Governor's Harbour February 1997); Retired Partner, KPMG Peat
Grand Cayman Marwick LLP.
Cayman Islands
British West Indies
</TABLE>
-60-
<PAGE> 61
<TABLE>
<CAPTION>
Position with
Name and Address Age Company Principal Occupations
- ---------------- --- ------- ---------------------
<S> <C> <C> <C>
Robert E. Greeley 66 Trustee of Master See "Directors and Officers of the
Page Mill Asset Management Trust Company."
433 California Street
Suite 900
San Francisco, CA 94104
Cornelius J. Pings* 69 Trustee of Master See "Directors and Officers of the
Association of American Trust Company."
Universities
1200 New York Avenue, NW
Suite 550
Washington, DC 20005
Monroe Haegele 53 President of CEO of Provident Distributors, Inc. (since
Provident Distributors, Inc. Master Trust 1993); formerly Vice Chairman of PNC
Four Falls Corporate Center Institutional Management Corp. (PIMC)
6th floor (1990 to 1992);formerly Partner in The Hay
West Conshohocken, PA 19428 Group (1981 to 1986); formerly Senior Vice
President at First Pennsylvania Company
(1978 to
</TABLE>
- ----------
* Dr. Pings is an "interested director" of the Company as defined in the
1940 Act.
-61-
<PAGE> 62
<TABLE>
<CAPTION>
Position with
Name and Address Age Company Principal Occupations
- ---------------- --- ------- ---------------------
<S> <C> <C> <C>
1981); formerly Vice President at
Chase Manhattan Bank (1974 to 1978).
Stephen M. Wynne 42 Vice President of See "Directors and Officers of the
Executive Vice President, Master Trust Company."
PFPC Inc.
400 Bellevue Parkway
Wilmington, DE 19809
J. Fergus McKeon 38 Treasurer of General Manager, PFPC International (since
80 Harcourt Street Master Trust 1993); formerly Chief Accountant, SBC-ISL
Dublin, Ireland (1990-1993).
Jay F. Nusblatt 36 Assistant See "Directors and Officers of the
Vice President, PFPC Inc. Treasurer of Company."
103 Bellevue Parkway Master Trust
Wilmington, DE 19809
Robert Kelly 29 Assistant Accounting Manager, PFPC International
80 Harcourt Street Treasurer of (since 1996); Accountant, Oppenheimer
Dublin, Ireland Master Trust Funds Inc. (1992 to 1996).
W. Bruce McConnel, III 55 Secretary of See "Directors and Officers of the
1345 Chestnut Street Master Trust Company."
Philadelphia National Bank Building,
Suite 1100
Philadelphia, PA 19107
Gary M. Gardner 46 Assistant See "Directors and Officers of the
Chief Counsel-Mutual Funds, Secretary of Company."
PNC Bank Master Trust
1600 Market Street,
28th Fl.
Philadelphia, PA 19103.
J. Robert Dugan 32 Assistant See "Directors and Officers of the
Counsel-Mutual Funds, Secretary of Company."
PNC Bank Master Trust
1600 Market Street
28th Fl.
</TABLE>
-62-
<PAGE> 63
<TABLE>
<CAPTION>
Position with
Name and Address Age Company Principal Occupations
- ---------------- --- ------- ---------------------
<S> <C> <C> <C>
Philadelphia, PA 19103
</TABLE>
- ----------
Each trustee receives an aggregate annual fee of $2,000 ($7,000 in the
case of any trustee who is not also a Director or Trustee of a feeder fund of
one of the portfolios of Master Trust) plus $500 per day for each travel day and
each day of a Board or committee meeting attended ($1,000 in the case of any
trustee who is not also a Director or Trustee of a feeder fund of one of the
portfolios of Master Trust), for his services as trustee of each of Master
Trust. Each trustee is also reimbursed for out-of-pocket expenses incurred as a
trustee. For its fiscal year ended February 28, 1998, Master Trust paid or
accrued for the account of its trustees as a group for services in all
capacities a total of $72,180; of that amount, $5,177, $19,305, and $48,198
were allocated to the Master Portfolios corresponding to the Asset Allocation,
Intermediate Bond and Blue Chip Funds, respectively (prior to June 23, 1997 the
Asset Allocation Fund operated as part of a master-feeder structure and
invested all of its respective assets in the Asset Allocation Master
Portfolio). The trustee's fees and reimbursements are allocated among all of
Master Trust's portfolios based on their relative net asset values. Drinker
Biddle & Reath LLP, of which Mr. McConnel is a partner, receives legal fees as
counsel to Master Trust.
The following table sets forth (i) the aggregate compensation
paid by the Company for the fiscal year ended February 28, 1998 to the Directors
and (ii) the aggregate compensation paid to such Directors for services on the
Company's Board and that of all other funds in the "Fund Complex" (as defined in
Schedule 14A under the Securities Exchange Act of 1934):
<TABLE>
<CAPTION>
====================================================================================================================================
NAME OF PERSON/ POSITION AGGREGATE PENSION OR ESTIMATED ANNUAL TOTAL COMPENSATION FROM
COMPENSATION FROM RETIREMENT BENEFITS BENEFITS UPON REGISTRANT AND FUND
THE COMPANY ACCRUED AS PART OF RETIREMENT COMPLEX(2) PAID TO
FUND EXPENSES(1) DIRECTORS
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Edward S. Bottum (3) Not Applicable Not Applicable Not Applicable $29,125
- ------------------------------------------------------------------------------------------------------------------------------------
William P. Carmichael (3) Not Applicable Not Applicable Not Applicable $27,625
- ------------------------------------------------------------------------------------------------------------------------------------
Thomas M. Collins(4) $46,750 $16,199 $50,500 $53,500
Director
- ------------------------------------------------------------------------------------------------------------------------------------
Douglas B. Fletcher $36,750 $23,195 $37,500 $36,750
Vice Chairman of the Board
- ------------------------------------------------------------------------------------------------------------------------------------
Robert E. Greeley(5) $36,750 $16,220 $37,500 $72,750
Director
- ------------------------------------------------------------------------------------------------------------------------------------
Kermit O. Hanson $35,750 $28,422 $ * (6) $40,250
Director
- ------------------------------------------------------------------------------------------------------------------------------------
Cornelius J. Pings(4) $69,250 $26,984 $40,500 $81,892
President and Chairman of
the Board
====================================================================================================================================
</TABLE>
- ----------
-63-
<PAGE> 64
(1) For the fiscal year ended February 28, 1998, the Company accrued on the
part of all of the directors an aggregate of $284,393 in retirement benefits.
(2) The "Fund Complex" consists of the Company, Master Trust, Time Horizon
Funds, Pacific Innovations Trust and Seafirst Retirement Funds (which were
merged into the Company on June 23, 1997). Fees from the Time Horizon Funds are
for the period from March 1, 1997 to February 28, 1998.
(3) Messrs. Bottum and Carmichael currently serve as Trustees of the
Pacific Innovations Trust and Time Horizon Funds.
(4) Mr. Collins and Dr. Pings also serve as Trustee for Master Trust.
(5) Mr. Greeley currently also serves as Trustee for the Time Horizon
Funds, Pacific Innovations Trust and Master Trust.
(6) Mr. Hanson served as Director until July 20, 1998. On July 20, 1998:
Mr. Hanson was entitled to retirement benefits of $170,995 (0.002%), $53,533
(0.002%), $7,516 (0.002%), $8,456 (0.002%), $12,527 (0.002%), $25,054 (0.002%),
$1,253 (0.002%), $626 (0.002%), $1,253 (0.002%), $626 (0.002%), $313 (0.002%),
$3,758 (0.002%), $1,253 (0.002%), $626 (0.002%), $1,253 (0.002%), $626 (0.002%),
$313 (0.002%), $3,758 (0.002%), $6,890 (0.002%), $4,384 (0.002%), $3,758
(0.002%), $11,588 (0.002%) and $626 (0.001%) from the Prime, Treasury, Treasury
Only, Government, Tax-Exempt Money, California Tax-Exempt Money Market,
Intermediate Bond, Corporate Bond, U.S. Government Securities, Short-Term
Government, National Municipal Bond, California Tax- Exempt Bond, Capital
Income, Asset Allocation, Aggressive Growth, Blue Chip and International Equity
Funds, respectively. Bank of America has agreed to reimburse the Company
$100,136 in the aggregate relating to these benefits.
INVESTMENT ADVISER
Bank of America serves as investment adviser to each Fund of
the Company. Bank of America was 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. As described in
the Prospectuses, the Feeder Funds have not retained the services of an
investment adviser because they seek to achieve their investment objectives by
investing all their assets in their corresponding Master Portfolio. In the
Investment Advisory Agreements with the Company and Master Trust, 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 officers from one
or more of the departments of Bank of America 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 subsidiaries and other affiliates of Bank of America or its
parent corporation. In addition, the agreement 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.
On April 13, 1998, BankAmerica Corporation ("BankAmerica") and
NationsBank Corporation ("NationsBank") announced a definitive agreement to
merge and form a new holding company to be named BankAmerica Corporation (the
"Merger"). The Merger is anticipated to close by the end of 1998, however, it is
subject to a number of approvals including shareholder and regulatory approvals.
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 .25% of the
average daily net assets of the Short-Term Government Fund; .30% of the net
assets of the Intermediate Bond Master Portfolio and California Municipal Bond
Fund; .35% of the net assets of each of the National Municipal Bond Fund and
U.S. Government Securities Fund; .40% of the net assets of the Asset Allocation
Fund; .45% of the net assets of each of the Capital Income Fund and Flexible
Income Fund; .50% of
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<PAGE> 65
the net assets of the Blue Chip Master Portfolio; .60% of the net assets of the
Aggressive Growth Fund; and .75% of the net assets of the International Equity
Fund for the services provided and expenses assumed pursuant to the particular
Investment Advisory Agreement. From time to time, Bank of America may
voluntarily waive fees or reimburse a particular Fund for expenses. Prior to
June 3, 1997, Bank of America was entitled to receive an investment advisory fee
at the annual rate of 0.45%, 0.75% and 0.55% of the respective average daily net
assets of the Intermediate Bond, Blue Chip and Asset Allocation Master
Portfolios. Prior to October 28, 1997, Bank of America was entitled to receive
an investment advisory fee at the annual rate of 0.40% of the daily net assets
of the California Municipal Bond Fund.
For the fiscal years indicated, the following advisory fees
(net of waivers) were paid or payable to Bank of America by the Aggressive
Growth, California Municipal Bond, Capital Income, U.S. Government Securities
Funds, International Equity Fund and Short-Term Government Fund as follows:
<TABLE>
<CAPTION>
---------------------------------------------------------------------
Year ended Year ended Year Ended
February 28, February 28, February 29,
1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Aggressive Growth Fund $1,239,141 $1,239,652 $ 935,275
- ---------------------------------------------------------------------------------------------------------------------
California Municipal Bond Fund $ 828,272 $ 857,206 $ 584,994
- ---------------------------------------------------------------------------------------------------------------------
Capital Income Fund $1,637,658 $1,220,622 $ 992,349
- ---------------------------------------------------------------------------------------------------------------------
U.S. Government Securities Fund $ 257,392 $ 283,471 $ 269,498
- ---------------------------------------------------------------------------------------------------------------------
International Equity Fund $ 232,581 $ 48,128(1) N/A
- ---------------------------------------------------------------------------------------------------------------------
Short-Term Government Fund $ 64,249 $ 12,022(2) N/A
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Period from September 1, 1996 to February 28, 1997. For the period from
May 13, 1996 (inception date) to August 31, 1996, the International Equity
Master Portfolio paid $0 in advisory fees (net of waivers) to Bank of America.
(2) Period from August 2, 1996 (inception date) to February 28, 1997.
-65-
<PAGE> 66
For the fiscal years indicated, Bank of America waived
advisory fees with respect to the Aggressive Growth, California Municipal Bond,
Capital Income, U.S. Government Securities, International Equity and Short-Term
Government Funds as follows:
<TABLE>
<CAPTION>
-------------------------------------------------------------------
Year ended Year ended Year ended
February 28, February 28, February 29,
1998 1997 1996
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Aggressive Growth Fund $ 0 $ 0 $ 0
- --------------------------------------------------------------------------------------------------------------------
California Municipal Bond Fund $194,717 $244,720 $234,006
- --------------------------------------------------------------------------------------------------------------------
Capital Income Fund $ 0 $ 0 $ 0
- --------------------------------------------------------------------------------------------------------------------
U.S. Government Securities Fund $211,393 $134,763 $ 41,779
- --------------------------------------------------------------------------------------------------------------------
International Equity Fund $232,580 $ 56,931(1) N/A(1)
- --------------------------------------------------------------------------------------------------------------------
Short-Term Government Fund $ 64,249 $ 12,022(2) N/A
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Period from September 1, 1996 to February 28, 1997. For the period from
May 13, 1996 (inception date) to August 31, 1996, Bank of America waived
advisory fees of $8,262 with respect to the International Equity Master
Portfolio.
(2) Period from August 2, 1996 (inception date) to February 28, 1997.
Except as noted below, for the fiscal years indicated Bank of
America waived its entire advisory fee with respect to the Intermediate Bond
Master Portfolio, Blue Chip Master Portfolio, Asset Allocation Fund (Asset
Allocation Master Portfolio for periods prior to June 23, 1997) and National
Municipal Bond Fund (Municipal Master Portfolio for periods prior to July 1,
1996) as follows:
<TABLE>
<CAPTION>
-------------------------------------------------------------------
Year ended Year ended Year ended
February 28, February 28, February 29,
1998 1997 1996
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Intermediate Bond Master $ 466,254(1) $ 428,287(2) $ 296,136
Portfolio
- -----------------------------------------------------------------------------------------------------------
Blue Chip Master Portfolio $3,362,041(1) $2,701,648(2) $1,574,388(3)
- -----------------------------------------------------------------------------------------------------------
Asset Allocation Fund $ 650,191(1) $1,046,406(2) $ 913,660(3)
- -----------------------------------------------------------------------------------------------------------
National Municipal Bond Fund(4) $ 48,653(1) $ 34,135(2) $ 24,739
- -----------------------------------------------------------------------------------------------------------
</TABLE>
(1) For the fiscal year ended February 28, 1998, Bank of America waived
$248,915, $262,519 and $48,653 in advisory fees with respect to the Intermediate
Bond Master Portfolio, Blue Chip Master Portfolio and National Municipal Bond
Fund, respectively. Prior to June 23, 1997, the Asset Allocation Fund invested
all of its assets in the Asset Allocation Master Portfolio. On June 23, 1997,
the Asset Allocation Fund withdrew its assets from the Asset Allocation Master
Portfolio and invested them directly in investment securities. For the period
from March 1, 1997 to June 23, 1997 the Asset Allocation Master Portfolio paid
advisory fees of $58,038 and Bank of America waived advisory fees of $302,575.
(2) For the fiscal year ended February 28, 1997, Bank of America waived
$256,439, $961,001, $735,797 and $0 in advisory fees with respect to the
Intermediate Bond Master Portfolio, Blue Chip Master Portfolio, Asset Allocation
Master Portfolio and National Municipal Bond Fund.
-66-
<PAGE> 67
(3) For the fiscal year ended February 29, 1996, Bank of America waived
$1,164,328 and $720,259, respectively, in advisory fees with respect to the Blue
Chip Master Portfolio and Asset Allocation Master Portfolio.
(4) Prior to July 1, 1996, the National Municipal Bond Fund invested all of
its assets in the Municipal Master Portfolio. On July 1, 1996, the National
Municipal Bond Fund withdrew assets from the Municipal Master Portfolio and
invested them directly in investment securities. For the period from March 1,
1996 to June 30, 1996 the Municipal Master Portfolio paid advisory fees of $0
and Bank of America waived advisory fees of $14,997.
Additionally, for the fiscal years indicated, Bank of America
and/or BISYS assumed certain operating expenses of the Intermediate Bond Fund,
Blue Chip Fund, Asset Allocation Fund, Municipal Master Portfolio, National
Municipal Bond Fund, U.S. Government Securities Fund, Flexible Income Fund,
International Equity Fund, and Short-Term Government Fund as follows:
<TABLE>
<CAPTION>
----------------------------------------------------------------
Year ended Year ended Year ended
February 28, February 28, February 29,
1998 1997 1996
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Intermediate Bond Fund $ 0 $146,716 $ 0
- -------------------------------------------------------------------------------------------------------------
Blue Chip Fund $ 0 $ 0 $ 0
- -------------------------------------------------------------------------------------------------------------
Asset Allocation Fund $ 0 $ 31,598 $ 0
- -------------------------------------------------------------------------------------------------------------
Municipal Master Portfolio N/A $ 0(1) $ 0
- -------------------------------------------------------------------------------------------------------------
National Municipal Bond Fund $ 0 $ 0 $ 0
- -------------------------------------------------------------------------------------------------------------
U.S. Government Securities Fund $ 41,459 $ 93,097 $ 0
- -------------------------------------------------------------------------------------------------------------
Flexible Income Fund $ 2,889 $ 0 $ 0
- -------------------------------------------------------------------------------------------------------------
International Equity Fund $ 54,966 $132,666(2) N/A
- -------------------------------------------------------------------------------------------------------------
Short-Term Government Fund $ 52,181 $114,415(3) N/A
- -------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Prior to July 1, 1996, the National Municipal Bond Fund invested all of
its assets in the Municipal Master Portfolio. On July 1, 1996, the National
Municipal Bond Fund withdrew assets from the Municipal Master Portfolio and
invested them directly in investment securities. Assumed operating expenses are
for the period March 1, 1996 to June 30, 1996.
(2) Period from September 1, 1996 to February 28, 1997. For the period from
May 13, 1996 (inception date) to August 31, 1996, Bank of America assumed
operating expenses of $41,154 with respect to the International Equity Master
Portfolio.
(3) Period from August 2, 1996 (inception date) to February 28, 1997.
For the periods indicated, Bank of America waived its entire
advisory fee with respect to the Flexible Income Fund (formerly, Corporate Bond
Fund) (and Corporate Bond Master Portfolio for the period prior to September 1,
1996) as follows:
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<PAGE> 68
<TABLE>
<CAPTION>
-----------------------------------------------------------------------
Year ended Year ended Year ended
February 28, February 28, February 29,
1998 1997 1996
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Flexible Income $164,104(2) $70,991(1) $144,324
Fund
- ---------------------------------------------------------------------------------------------------
</TABLE>
(1) Prior to September 1, 1996, the Flexible Income Fund (formerly,
Corporate Bond Fund) invested all of its assets in the Corporate Bond Master
Portfolio. On September 1, 1996, the Flexible Income Fund withdrew assets from
the Corporate Bond Master Portfolio and invested them directly in investment
securities. Fees waived are for the period from September 1, 1996 to February
28, 1997. For the same period Bank of America waived $129,971 in advisory fees
with respect to the Flexible Income Fund. For the period from March 1, 1996 to
August 31, 1996 the Corporate Bond Master Portfolio paid advisory fees of $0 and
Bank of America waived $69,539 in advisory fees with respect to the Corporate
Bond Master Portfolio.
(2) For the fiscal year ended February 28, 1998, Bank of America waived
$164,104 in advisory fees with respect to the Flexible Income Fund.
The Investment Advisory Agreements between Bank of America and
the Company will be in effect until October 31, 1999, and will continue in
effect with respect to a particular Fund or Master Portfolio from year to year
thereafter only so long as such continuation is approved at least annually by
(i) the Board of Trustees/Directors of the particular Company or the vote of a
"majority," as defined in the 1940 Act, of the outstanding voting securities of
such particular Master Portfolio or Fund, and (ii) a majority of those
trustees/directors of the particular Company who are not "interested persons,"
as defined in the 1940 Act, of any party to the particular Investment Advisory
Agreement, acting in person at a meeting called for the purpose of voting on
such approval. Each 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 with respect to a particular Master
Portfolio or Fund at any time without penalty upon 60 days' written notice by
the Board of Trustees/Directors of the Company, by vote of the holders of a
majority of a Master Portfolio's or Fund's outstanding voting securities, or by
Bank of America.
See "Management - Administrator" for instances where the
investment adviser is required to make expense reimbursements to the Funds.
The Investment Advisory Agreements 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.
SUB-ADVISER
Wellington Management, with principal offices at 75 State
Street, Boston, Massachusetts 02109, serves as sub-adviser to the International
Equity Fund. Wellington Management is a professional investment counseling firm
that provides investment services to investment companies, employee benefit
plans, endowments, foundations, and other institutions and individuals. The
Sub-Adviser's predecessor organizations have provided investment advisory
services to investment companies since 1933 and to investment counseling clients
since 1960.
Under the Sub-Advisory Agreement between Bank of America and
Wellington Management, the Sub-Adviser, subject to the oversight and supervision
of the Adviser and the Company's Board of Directors,
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<PAGE> 69
provides a continuous investment program for the International Equity Fund,
including investment research and management with respect to all securities and
investments and cash equivalents in the International Equity Fund. The
Sub-Adviser also determines from time to time what securities and other
investments will be purchased, retained or sold by the International Equity
Fund. The Sub-Advisory Agreement provides that Bank of America will pay
Wellington Management a quarterly fee based on the average month-end net assets
of the International Equity Fund, at the annual rate of 0.40% of the Fund's
first $50 million of average month-end net assets, plus 0.30% of the next $100
million of the Fund's average month-end net assets, plus 0.25% of the next $350
million of the Fund's average month-end net assets, plus 0.20% of the Fund's
average month-end net assets over $500 million.
Pursuant to the sub-advisory agreement, the Sub-Adviser is not liable
for any error of judgment or mistake of law or for any loss suffered by the
Company in connection with the performance of the sub-advisory agreement, except
that the Sub-Adviser is liable to the Company and the Adviser for any loss
resulting from a breach of fiduciary duty with respect to the receipt of
compensation for services or any loss resulting from willful misfeasance, bad
faith or negligence on the part of the Sub-Adviser in the performance of its
duties or from reckless disregard by it of its obligations and duties under the
sub-advisory agreement.
The sub-advisory agreement between Bank of America and Wellington
Management will be in effect until October 31, 1999 and continue in effect for
successive annual periods ending on October 31, provided such continuance is
specifically approved at least annually (a) by the vote of a majority of those
members of the Company's Board of Directors who are not interested persons of
any party to the sub-advisory agreement, cast in person at a meeting called for
the purpose of voting on such approval, and (b) by the Company's Board of
Directors or by vote of a majority of the outstanding voting securities of the
International Equity Fund. The Agreement may be terminated at any time, without
the payment of any penalty, by the Adviser or by the Company (in the case of the
Company, by vote of the Company's Board of Directors or by vote of a majority of
the outstanding voting securities of the International Equity Fund) on sixty
days' written notice to the Sub-Adviser, or by the Sub- Adviser, on sixty days'
written notice to the Company, provided that in each such case, notice is given
simultaneously to the Adviser. In addition, in the event of the termination of
the Investment Advisory Agreement with respect to the International Equity Fund
for any reason (whether by the Company, by the Adviser or by operation of law)
the sub-advisory agreement terminates upon the effective date of such
termination of the Investment Advisory Agreement.
For the fiscal year ended February 28, 1998, Wellington
Management earned advisory fees of $32,702 and Wellington Management waived
advisory fees of $76,305. For the period January 1, 1997 to February 28, 1997,
Wellington Management earned advisory fees of $2,924 and Wellington Management
waived advisory fees of $6,823.
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 of Governors") 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
-69-
<PAGE> 70
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 of Governors 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 were properly
presented, a court should hold that Bank of America may perform the services for
the Portfolios contemplated by the particular 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 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 PDI. 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 Companies expect that Bank of
America would consider the possibility of offering to perform some or all of the
services now provided by PDI. 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 Companies 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 PDI. 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 a particular Company's Board of Directors/Trustees.
ADMINISTRATOR
Bank of America (the "Administrator") serves as administrator
of the Funds. For the period from March 1, 1997 through September 15, 1997, the
BISYS Group, Inc., through its wholly-owned subsidiary BISYS Fund Services L.P.
(collectively, "BISYS"), served as administrator to the Fund. For the period
September 15, 1997 through February 28, 1998, Bank of America served as the
Funds' administrator. PFPC International Ltd. serves as administrator and
accounting services agent of the Intermediate Bond and Blue Chip Master
Portfolios. Bank of America and PFPC International Ltd. are each referred to as
an "Administrator" and collectively referred to as the "Administrators." Prior
to November 1, 1996, Concord Holding Corporation, an indirect, wholly-owned
subsidiary of BISYS served as the Funds' and Master Portfolios' administrator
("Concord Holding").
-70-
<PAGE> 71
Bank of America provides administrative services to the Funds
as described in the Funds' Prospectuses pursuant to an Administration Agreement
with the Company. Unless sooner terminated, the Administration Agreement
continues in effect until October 31, 1999 and thereafter will be extended with
respect to each Fund for successive periods of one year, provided that each such
extension is specifically approved at least annually by (a) vote of a majority
of those members of the Company's Board of Directors who are not parties to the
administration 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)
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
cause and without payment of any penalty by vote of a majority of the Company's
Board of Directors or by vote of a majority of the outstanding voting securities
of any Fund upon 60 days' written notice to the Administrator, or by the
Administrator at any time, without payment of any penalty upon 90 days' written
notice to the Company. The agreement will immediately terminate in the event of
its "assignment."
The Company has agreed to pay the Administrator fees for its
services as administrator of the Funds, computed daily and payable monthly, at
the annual rates of .15% of the average daily net assets of the Intermediate
Bond Fund, Blue Chip Fund and Asset Allocation Fund; .20% of the average daily
net assets of the U.S. Government Securities, National Municipal Bond Fund,
Short-Term Government, Capital Income, Flexible Income, International Equity and
California Municipal Bond Funds; and .30% of the average daily net assets of the
Aggressive Growth Fund. Master Trust I has agreed to pay PFPC International Ltd.
fees for its services as administrator of the Master Portfolios, computed daily
and payable monthly, at the annual rates of .05% of the average daily net assets
of the Intermediate Bond Master Portfolio and Blue Chip Master Portfolio. The
fees payable to the Administrators are not subject to reduction as the value of
each Fund's and Master Portfolio's net assets increase. From time to time, Bank
of America may voluntarily waive fees or reimburse a Fund or Master Portfolio
for expenses. Prior to October 28, 1997, BISYS, Concord Holding or Bank of
America was entitled to receive an administration fee payable at the annual rate
of 0.30% of the California Municipal Bond Fund's average daily net assets. Prior
to July 1, 1996, September 1, 1996, September 1, 1996 and June 23, 1997, the
following Funds and Master Portfolios paid administration fees at the following
annual rates: 0.15% of the National Municipal Bond Fund's and 0.05% of the
Municipal Master Portfolio's average daily net assets, 0.15% of the Flexible
Income Fund's and 0.05% of the Corporate Bond Master Portfolio's average daily
net assets, 0.15% of the International Equity Fund's and 0.05% of the
International Equity Master Portfolio's average daily net assets and 0.15% of
the Asset Allocation Fund's and 0.05% of the Asset Allocation Master Portfolio's
average daily net assets.
For the fiscal years indicated, the following administration
fees (net of waivers) were paid or payable to, Bank of America, BISYS or Concord
Holding by the Aggressive Growth Fund, California Municipal Bond Fund, Capital
Income Fund, U.S. Government Securities Fund, Short-Term Government Fund,
International Equity Fund and International Equity Master Portfolio as follows:
<TABLE>
<CAPTION>
----------------------------------------------------------
Year ended Year ended Year ended
February 28, February 28, February 29,
1998 1997 1996
- --------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Aggressive Growth Fund $619,570(1) $619,826 $467,638
- --------------------------------------------------------------------------------------------------
California Municipal Bond Fund $608,975(1) $642,905 $438,745
- --------------------------------------------------------------------------------------------------
Capital Income Fund $727,852(1) $542,500 $441,044
- --------------------------------------------------------------------------------------------------
U.S. Government Securities Fund $147,083(1) $162,212 $153,997
- --------------------------------------------------------------------------------------------------
Short-Term Government Fund $ 61,399(1) $ 0(2) N/A
- --------------------------------------------------------------------------------------------------
International Equity Fund $ 62,021(1) $ 0(3) N/A
- --------------------------------------------------------------------------------------------------
International Equity Master N/A $ 0(4) N/A
Portfolio
- --------------------------------------------------------------------------------------------------
</TABLE>
-71-
<PAGE> 72
(1) $294,171, $206,346, $355,132, $17,219, $0 and $0 was paid to Bank of
America and $325,399, $256,592, $322,702, $13,303, $0 and $0 was paid to BISYS
with respect to the Aggressive Growth Fund, California Municipal Bond Fund,
Capital Income Fund, U.S. Government Securities Fund, Short-Term Government
Fund, International Equity Fund and International Equity Portfolio.
(2) Period from August 2, 1996 (inception date of fund) to February 28,
1997.
(3) Period from May 13, 1996 (inception date of fund) to February 28, 1997.
(4) Prior to September 1, 1996, the International Equity Fund invested all
of its assets in the International Equity Master Portfolio. On September 1,
1996, the International Equity Fund withdrew its assets from the International
Equity Master Portfolio and invested directly in investment securities. For the
period from May 13, 1996 (inception date) to August 31, 1996, the International
Equity Master Portfolio paid administration fees (net of waivers) of $0 to
Concord Holding and Concord Holding waived administration fees of $551 with
respect to the International Equity Master Portfolio.
-72-
<PAGE> 73
For the fiscal years indicated, Bank of America, BISYS or
Concord Holding waived administration fees with respect to the California
Municipal Bond, U.S. Government Securities, Short-Term Government and
International Equity Funds as follows:
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------
Year ended Year ended Year ended
February 28, February 28, February 29,
1998 1997 1996
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
California Municipal Bond Fund $43,399 Bank of America $183,837 $175,505
$102,638 BISYS
- --------------------------------------------------------------------------------------------------------------------------
U.S. Government Securities Fund $49,555 Bank of America $ 77,220 $ 23,875
$67,006 BISYS
- --------------------------------------------------------------------------------------------------------------------------
Short-Term Government Fund $27,820 Bank of America $ 9,617(2) N/A
$23,579 BISYS
- --------------------------------------------------------------------------------------------------------------------------
International Equity Fund $33,933 Bank of America $ 15,032(3) N/A
$28,088 BISYS
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) $0, $43,399, $0, $49,555, $27,820 and $33,933 was waived by Bank of America
and $0, $102,638, $0, $67,006, $23,579 and $28,088 was waived by BISYS.
(2) Period from August 2, 1996 (inception date of fund) to February 28, 1997.
(3) Period from May 13, 1996 (inception date of fund) to February 28, 1997.
Additionally, for the fiscal years indicated, Bank of America,
BISYS or Concord Holding reimbursed operating expenses of the Blue Chip Fund,
Asset Allocation Fund, Intermediate Bond Fund, National Municipal Bond Fund,
Municipal Master Portfolio, Flexible Income Fund, Corporate Bond Master
Portfolio, and International Equity Fund as follows:
<TABLE>
<CAPTION>
---------------------------------------------------------------------------
Year ended February Year ended February Year ended February
28, 1998 28, 1997 29, 1996
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Blue Chip Fund $ 0 $ 303 $150,472
- ------------------------------------------------------------------------------------------------------------------
Asset Allocation Fund $ 0 $ 31,598 $192,545
- ------------------------------------------------------------------------------------------------------------------
Intermediate Bond Fund $ 0 $146,716 $253,991
- ------------------------------------------------------------------------------------------------------------------
National Municipal Bond Fund $41,459 $147,200 $172,071
- ------------------------------------------------------------------------------------------------------------------
Municipal Master Portfolio(1) N/A $ 0 $169,773
- ------------------------------------------------------------------------------------------------------------------
Flexible Income Fund $ 2,889 $ 297 $ 0
- ------------------------------------------------------------------------------------------------------------------
Corporate Bond Master N/A $ 0 $233,360
Portfolio(2)
- ------------------------------------------------------------------------------------------------------------------
International Equity Fund $54,966 $132,666(6) N/A
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
- ----------
(1) Prior to July 1, 1996, the National Municipal Bond Fund invested all of
its assets in the Municipal Master Portfolio. On July 1, 1996, the National
Municipal Bond Fund withdrew its investment from the Municipal Master Portfolio
and invested directly in investment securities. For the period March 1, 1996 to
June 30, 1996 Concord Holding reimbursed operating expenses of $0 with respect
to the Municipal Master Portfolio.
-73-
<PAGE> 74
(2) Prior to September 1, 1996, the Flexible Income Fund invested all of
its assets in the Corporate Bond Master Portfolio. On September 1, 1996, the
Flexible Income Fund withdrew its investment from the Corporate Bond Master
Portfolio and invested directly in investment securities. For the period March
1, 1996 to August 31, 1996, Concord Holding reimbursed operating expenses of $0
with respect to the Corporate Bond Master Portfolio.
(3) Period from May 13, 1996 (inception date of fund) to February 28, 1997.
Except as noted below, for the fiscal years indicated Bank of
America, PFPC International Ltd., BISYS or Concord Holding waived its entire
administration fee with respect to the Intermediate Bond Fund and the
Intermediate Bond Master Portfolio, the Blue Chip Fund and the Blue Chip Master
Portfolio, the Asset Allocation Fund and the Asset Allocation Master Portfolio
and National Municipal Bond Fund and the Municipal Master Portfolio as follows:
<TABLE>
<CAPTION>
------------------------------------------------------------------------
Year ended Year ended Year ended February
February 28, February 28, 1997 29, 1996
1998
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Intermediate Bond Fund $ 94,118(2) $ 24,165 $ 9,952
- ------------------------------------------------------------------------------------------------------------------
Intermediate Bond Master $ 69,900(3) $ 47,588(4) $ 30,769
Portfolio
- ------------------------------------------------------------------------------------------------------------------
Blue Chip Fund $673,969(2) $ 153,571 $ 44,971
- ------------------------------------------------------------------------------------------------------------------
Blue Chip Master Portfolio $296,792(3) $180,110(4) $104,889(5)
- ------------------------------------------------------------------------------------------------------------------
Asset Allocation Fund $258,691(2) $ 41,432 $ 19,909
- ------------------------------------------------------------------------------------------------------------------
Asset Allocation Master N/A $ 94,685(4) $ 83,060(5)
Portfolio(1)
- ------------------------------------------------------------------------------------------------------------------
National Municipal Bond Fund $ 27,802(2) $ 25,897(4) $ 10,543
- ------------------------------------------------------------------------------------------------------------------
Municipal Master Portfolio(1) N/A $ 0 $ 3,534
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
- ----------
(1) Prior to June 23, 1997, and July 1, 1996, the Asset Allocation and
National Municipal Bond Funds invested all of their respective assets in the
Asset Allocation and Municipal Master Portfolios. On June 23, 1997 and July 1,
1996, the Asset Allocation and National Municipal Bond Funds withdrew their
respective assets from the Asset Allocation and Municipal Master Portfolios and
invested directly in investment securities. For the period from March 1, 1996 to
June 30, 1996 the Municipal Master Portfolio paid administration fees of $0 and
Concord Holding waived administration fees of $1,951 with respect to the
Municipal Master Portfolio. For the period from March 1, 1997 to June 23, 1997,
the Asset Allocation Master Portfolio paid administrative fees of $5,280 and
Concord Holding waived administrative fees of $27,800 with respect to the Asset
Allocation Master Portfolio.
(2) $4,035, $0; $0, and $12,714 was waived by Bank of America and $35,332
$73,397, $17,413, and $15,088 was waived by BISYS with respect to the
Intermediate Bond, Blue Chip, Asset Allocation and National Municipal Bond
Funds.
-74-
<PAGE> 75
(3) $1,324, $0, and $0 was waived by PFPC International Ltd. and
$16,513, $17,122, and $27,800 was waived by BISYS/Concord Holding with respect
to the Intermediate Bond, Blue Chip and Asset Allocation Master Portfolio.
(4) For the fiscal year ended February 28, 1997, BISYS or Concord Holding
waived $28,508, $64,005, $66,954 and $0 with respect to the Intermediate Bond
Master Portfolio, Blue Chip Master Portfolio, Asset Allocation Master Portfolio
and National Municipal Bond Fund, respectively.
(5) For the fiscal year ended February 29, 1996, Concord Holding waived
$77,922 and $65,491, respectively in administration fees with respect to the
Blue Chip Master Portfolio and Asset Allocation Master Portfolio.
For the periods indicated, Bank of America, BISYS or Concord
Holding waived its entire administration fee with respect to the Flexible Income
Fund and the Corporate Bond Master Portfolio as follows:
<TABLE>
<CAPTION>
----------------------------------------------------------
Year ended Year ended Year ended
February 28, February 28, February 29,
1998 1997 1996
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Flexible Income Fund 72,940(2) $54,670 $48,108
- ------------------------------------------------------------------------------------------------
Corporate Bond Master N/A $ 0 $16,036
Portfolio(1)
- ------------------------------------------------------------------------------------------------
</TABLE>
(1) Prior to September 1, 1996, the Flexible Income Fund invested all of
its assets on the Corporate Bond Master Portfolio. On September 1, 1996, the
Flexible Income Fund withdrew its investment from the Corporate Bond Master
Portfolio and invested them directly in portfolio securities. For the period
from March 1, 1996 to August 31, 1996, the Corporate Bond Master Portfolio paid
administration fees of $0 and Concord Holding waived administration fees of
$7,727 with respect to the Corporate Bond Master Portfolio.
(2) $34,613 was waived by Bank of America and $38,327 was waived by BISYS
with respect to the Flexible Income Fund.
During the course of the Company's fiscal year, Bank of
America and other service providers may prospectively waive payment of fees
and/or assume certain expenses of one or more of the Master Portfolios or Funds,
as a result of competitive pressures and in order to preserve and protect the
business and reputation of these entities. 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 (with respect to the
National Municipal Bond Fund, California Municipal Bond Fund, U.S. Government
Securities Fund, Capital Income Fund and Aggressive Growth Fund) and PFPC (with
respect to the Flexible Income Fund, International Equity Fund, Short-Term
Government Fund, Asset Allocation Fund, Intermediate Bond Fund and Blue Chip
Fund) for certain fund accounting services which are borne by the Funds. See
"General Information--Custodian, Accounting Agent and Transfer Agent" below.
Expenses borne by the Funds and Master Portfolios include taxes, interest,
brokerage fees and commissions, if any, fees of Board members who are not
officers,
-75-
<PAGE> 76
directors, partners, employees or holders of 5% or more of the outstanding
voting securities of Bank of America or their subcontractors or any of their
affiliates, SEC fees and state securities registration and qualification fees,
advisory fees, fees payable to shareholder organizations, fees for special
management services, 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 or any supplement or
amendment thereto, necessary for the continued effective registration of shares
under the 1933 Act or state securities laws, costs of printing and distributing
any prospectus, supplement or amendment thereto for existing shareholders, cost
of shareholders' and interestholders' reports and corporate meetings and any
extraordinary expenses. Certain shareholder servicing (and/or certain
distribution fees with respect to the Non-Feeder Funds) in connection with
Pacific Horizon's shares are also paid by Pacific Horizon. See "Distributor and
Plan Payments."
The Company's Administration Agreement provides that Bank of
America shall not be liable for any error of judgment or mistake of law or any
loss suffered by the Company or the Funds in connection with the performance of
the Administration Agreement, 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 under the Administration
Agreement. Under its Administration and Accounting Services Agreement with
Master Trust, PFPC International Ltd. is obligated to exercise care and
diligence in the performance of its duties, to act in good faith and to use its
best efforts, within reasonable limits, in performing services thereunder. PFPC
International Ltd. shall be liable for any damages arising out of its failure to
perform its duties under the administration and accounting services agreement to
the extent such damages arise out of its willful misfeasance, bad faith,
negligence or reckless disregard of its duties.
Bank of America may from time to time employ such person or
persons as it may believe to be particularly fitted to assist in the performance
of the Administration Agreement; provided, however, that the compensation of
such person or persons shall be paid by Bank of America and Bank of America
shall be as fully responsible to the Company for the acts and omissions of any
subcontractor as it is for its own acts and omissions. The Bank of New York
("BONY") (with respect to the National Municipal Bond Fund, California Municipal
Bond Fund, U.S. Government Securities Fund, Capital Income Fund and Aggressive
Growth Fund) and PFPC (with respect to the Flexible Income Fund, International
Equity Fund, Short-Term Government Fund, Asset Allocation Fund, Intermediate
Bond Fund and Blue Chip Fund) provide the Funds with certain accounting services
pursuant to separate fund accounting services agreements with the Administrator.
Under the fund accounting services agreements, BONY and PFPC have agreed to
provide certain accounting, bookkeeping, pricing, dividend and distribution
calculation services with respect to the Funds. The monthly fees charged by BONY
and PFPC under the fund accounting services agreements are borne by the Funds.
Bank of America has also entered into an agreement with PFPC
to provide certain sub-administration services to the Funds as described in the
Prospectuses. The monthly fees charged by PFPC for these services under the sub-
administration agreement are borne by Bank of America.
PFPC International Ltd. may assign its rights and delegate its
duties under its Administration and Accounting Services Agreement to any
wholly-owned direct or indirect subsidiary of PNC Bank, N.A. or PNC Bank Corp.,
provided, however that PFPC International Ltd. shall be as fully responsible to
Master Trust for the acts and omissions of any delegate as PFPC International
Ltd. is for its own acts and omissions.
-76-
<PAGE> 77
DISTRIBUTOR AND PLAN PAYMENTS
Provident Distributors, Inc. ("PDI" or the "Distributor") acts
as distributor of the shares of Pacific Horizon. Shares are sold on a continuous
basis by the Distributor. Prior to September 15, 1997, Concord Financial Group,
Inc. ("CFG"), a wholly owned subsidiary of BISYS, acted as distributor for the
Funds.
The Distributor has agreed to use its best efforts to effect
sales of shares of the Funds although it is not obliged to sell any certain
number of shares. The distribution agreement became effective September 15, 1997
and, unless sooner terminated, shall continue in effect with respect to each
Fund until October 31, 1999. 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 Pacific Horizon's Board of Directors
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 Pacific Horizon's Board of Directors 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 Pacific Horizon at any time, without the payment
of any penalty, by vote of a majority of Pacific Horizon's entire Board of
Directors 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
Pacific Horizon. The agreement will automatically and immediately terminate in
the event of its "assignment".
For the fiscal years ended February 28, 1998, February 28,
1997 and February 29, 1996, PDI or CFG received sales loads in connection with
the purchase of A shares of the Aggressive Growth, California Municipal Bond,
U.S. Government Securities, Capital Income, Intermediate Bond, Blue Chip, Asset
Allocation, National Municipal Bond, Short-Term Government and International
Equity Funds as follows:
Fiscal Year Ended February 28, 1998
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------
Total Sales Load Amount of Total Sales Amount of Total
Received By PDI or CFG Load Retained By PDI Sales Load Retained
or CFG By Bank of America
and its Affiliates
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Aggressive Growth Fund $187,565 $ 25,976(1) $152,093
- -------------------------------------------------------------------------------------------------------------------------
California Municipal Bond Fund $ 68,983 $ 7,840(1) $ 56,751
- -------------------------------------------------------------------------------------------------------------------------
U.S. Government Securities Fund $ 20,622 $ 2,003(1) $ 15,798
- -------------------------------------------------------------------------------------------------------------------------
Capital Income Fund $741,867 $86,359(1) $563,216
- -------------------------------------------------------------------------------------------------------------------------
Intermediate Bond Fund $ 4,471 $ 505(1) $ 3,950
- -------------------------------------------------------------------------------------------------------------------------
Blue Chip Fund $802,108 $91,344(1) $709,034
- -------------------------------------------------------------------------------------------------------------------------
Asset Allocation Fund $ 92,800 $10,024(1) $ 80,281
- -------------------------------------------------------------------------------------------------------------------------
National Municipal Bond Fund $ 17,666 $ 1,970(1) $ 15,655
- -------------------------------------------------------------------------------------------------------------------------
Flexible Income Fund $ 16,587 $ 1,079(1) $ 8,452
- -------------------------------------------------------------------------------------------------------------------------
Short-Term Government Fund $ 0 $ 0 $ 0
- -------------------------------------------------------------------------------------------------------------------------
International Equity Fund $ 81,304 $13,479(1) $ 58,733
=========================================================================================================================
</TABLE>
-77-
<PAGE> 78
(1) $790, $667, $0, $12,083, $1, $1,798, $12, $28, $4, and $11 was retained
by PDI and $25,186, $7,173, $2,003, $74,276, $504, $89,546, $10,012, $1,942,
$1,075, and $13,468 was retained by CFG from the Aggressive Growth, California
Municipal Bond, U.S. Government Securities, Capital Income, Intermediate Bond,
Blue Chip, Asset Allocation, National Municipal Bond, Flexible Income and
International Equity Funds, respectively.
Fiscal Year Ended February 28, 1997
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------
Total Sales Load Amount of Total Sales Amount of Total
Received By CFG Load Retained By CFG Sales Load Retained
By Affiliates of
Bank of America
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Aggressive Growth Fund $1,088,000(1) $120,955 $ 938,206
- -----------------------------------------------------------------------------------------------------------------------------
California Municipal Bond Fund $ 591,000(1) $ 45,746 $ 542,086
- -----------------------------------------------------------------------------------------------------------------------------
U.S. Government Securities Fund $ 179,000(1) $ 19,990 $ 161,482
- -----------------------------------------------------------------------------------------------------------------------------
Capital Income Fund $2,424,000(1) $268,543 $2,094,439
- -----------------------------------------------------------------------------------------------------------------------------
Intermediate Bond Fund $ 92,000(1) $ 10,026 $ 82,259
- -----------------------------------------------------------------------------------------------------------------------------
Blue Chip Fund $2,418,000(1) $268,770 $2,128,530
- -----------------------------------------------------------------------------------------------------------------------------
Asset Allocation Fund $ 421,000(1) $ 47,026 $ 373,436
- -----------------------------------------------------------------------------------------------------------------------------
National Municipal $ 203,000(1) $ 21,986 $ 180,834
Bond Fund
- -----------------------------------------------------------------------------------------------------------------------------
Flexible Income Fund $ 103,000(1) $ 11,522 $ 90,340
- -----------------------------------------------------------------------------------------------------------------------------
Short-Term Government Fund2 $ 0(1) $ 0 $ 0
- -----------------------------------------------------------------------------------------------------------------------------
International Equity Fund3 $ 115,000(1) $ 12,765 $ 101,858
- -----------------------------------------------------------------------------------------------------------------------------
</TABLE>
Fiscal Year Ended February 29, 1996
<TABLE>
<CAPTION>
-------------------------------------------------------------------------
Total Sales Load Amount of Total Sales Amount of Total
Received By CFG Load Retained By CFG Sales Load Retained
By Affiliates of
Bank of America
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Aggressive Growth Fund $ 805,092(4) $118,403 $ 653,024
- --------------------------------------------------------------------------------------------------------------------
California Municipal Bond Fund $1,180,348(1) $131,821 $1,048,152
- --------------------------------------------------------------------------------------------------------------------
U.S. Government Securities Fund $ 571,074(1) $ 63,560 $ 505,941
- --------------------------------------------------------------------------------------------------------------------
Capital Income Fund $1,746,063(1) $202,102 $1,493,113
- --------------------------------------------------------------------------------------------------------------------
Intermediate Bond Fund $ 460,801(1) $ 51,076 $ 408,407
- --------------------------------------------------------------------------------------------------------------------
Blue Chip Fund $2,138,130(1) $255,167 $1,875,240
- --------------------------------------------------------------------------------------------------------------------
Asset Allocation Fund $ 642,818(1) $ 69,818 $ 569,332
- --------------------------------------------------------------------------------------------------------------------
National Municipal $ 370,172(1) $ 40,099 $ 325,350
Bond Fund
- --------------------------------------------------------------------------------------------------------------------
Flexible Income Fund $ 152,616 $ 17,586 $ 133,287
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
-78-
<PAGE> 79
- ----------
1 Balance was paid to selling dealers.
2 Period from August 2, 1996 (inception date of fund) to February 28,
1997.
3 Period from May 13, 1996 (inception date of fund) to February 28, 1997.
4 Balance was paid to selling dealers.
The following table shows all sales loads, commissions and
other compensation received by PDI or CFG directly or indirectly from each of
the Aggressive Growth Fund, California Municipal Bond Fund, U.S. Government
Securities Fund, Capital Income Fund, Intermediate Bond Fund, Blue Chip Fund,
Asset Allocation Fund, National Municipal Bond Fund, Flexible Income Fund,
Short-Term Government Fund and International Equity Fund during each fund's
fiscal year ended February 28, 1998.
<TABLE>
<CAPTION>
Net Underwriting Compensation on Brokerage Other
Discounts and Redemption and Commissions in Compensation(3)
Commissions(1) Commissions(1) connection with Fund
Transactions
<S> <C> <C> <C> <C>
Aggressive Growth Fund $25,976(4) 0 0 $467,289
California Municipal Bond Fund $ 7,840(4) 0 0 $300,259
U.S. Government Securities Fund $ 2,003(4) 0 0 $ 19,782
Capital Income Fund $86,359(4) 0 0 $417,280
Intermediate Bond Fund $ 505(4) 0 0 $ 13,385
Blue Chip Fund $91,344(4) 0 0 $229,381
Asset Allocation Fund $10,024(4) 0 0 $ 85,196
National Municipal Bond Fund $ 1,970(4) 0 0 $ 0
Flexible Income Fund $ 1,079(4) 0 0 $ 26,183
Short-Term Government Fund $ 0(4) 0 0 $ 0
International Equity Fund $13,479(4) 0 0 $ 6,583
</TABLE>
- ----------
(1) Represents amounts received from front-end sales charge on A Shares.
-79-
<PAGE> 80
(2) Represents amounts received from contingent deferred sales charges on B
Shares. The basis on which such sales charges are paid by described in the
Prospectuses. As of February 28, 1998, no B Shares were offered.
(3) Represents the total of (i) amounts paid to BISYS or Concord Holding
for administrative services provided to the Fund (see "Management of the
Company-Administrator" above) and (ii) payments made under the Shareholder
Service Plan, Distribution Plan and Administrative and Shareholder Services Plan
(see discussion in next section) and retained by BISYS or CFG.
(4) $790, $667, $0, $12,083, $1, $1,798, $12 $28, $4 and $11 was received
by PDI and $25,186, $7,173, $2,003, $74,276, $504, $89,546, $10,012, $1,942,
$1,075, and $13,468 was received by CFG from the Aggressive Growth, California
Municipal Bond, U.S. Government Securities, Capital Income, Intermediate Bond,
Blue Chip, Asset Allocation, National Municipal Bond, Flexible Income and
International Equity Funds, respectively.
The Shareholder Services Plan. Pacific Horizon has adopted
separate Shareholder Services Plans (the "Plans") for SRF Shares and A Shares,
under which SRF Shares and A Shares of each Fund reimburse the Distributor for
shareholder servicing fees the Distributor pays to Service Organizations. The
fees paid under the Shareholder Services Plan for A Shares are in addition to
the sales loads on A Shares described above and in the Prospectus.
Under the Shareholder Service Plans for A Shares and SRF
Shares, Pacific Horizon pays the Distributor, with respect to the 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 facilities
dedicated for use by Pacific Horizon, 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 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.
Each Shareholder Services 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 SRF Shares or A
Shares of the Funds, as the case may be, 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
-80-
<PAGE> 81
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 a 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 a 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 a 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, 1998, the A Shares of
the Aggressive Growth, California Municipal Bond, Capital Income, U.S.
Government Securities, Intermediate Bond, Blue Chip, Asset Allocation, Flexible
Income, National Municipal Bond, Short-Term Government and International Equity
Funds were charged the following amounts pursuant to the Shareholder Service
Plan:
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------
Amount of Total
Amount of Total Shareholder Shareholder Service Fee
Total Shareholder Service Fee Paid to PDI or Paid to Bank of America
Service Fee CFG and its affiliates
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Aggressive Growth Fund $513,046 $244,047(1) $209,931
- ------------------------------------------------------------------------------------------------------------------------
California Municipal Bond $548,249 $194,600(1) $313,116
Fund
- ------------------------------------------------------------------------------------------------------------------------
Capital Income Fund $905,435 $54,546(1) $772,752
- ------------------------------------------------------------------------------------------------------------------------
U.S. Government $182,327 $7,155 $129,541
Securities Fund [$39,898 waived]
- ------------------------------------------------------------------------------------------------------------------------
Intermediate Bond Fund $85,538 $9,818(1) $40,786
[$26,307 waived]
- ------------------------------------------------------------------------------------------------------------------------
Blue Chip Fund $539,237 $37,962(1) $476,702
- ------------------------------------------------------------------------------------------------------------------------
Asset Allocation Fund $103,328 $3,724(1) $86,340
[$2,708 waived]
- ------------------------------------------------------------------------------------------------------------------------
Flexible Income Fund $90,532 $40,731(1) 18,541
[$17,972 waived]
- ------------------------------------------------------------------------------------------------------------------------
National Municipal Bond $34,753 $13(1) $2,159
Fund [$32,516 waived]
- ------------------------------------------------------------------------------------------------------------------------
Short-Term Government $64,249 $0(1) $0
Fund [$64,249 waived]
- ------------------------------------------------------------------------------------------------------------------------
International Equity Fund $76,721 $6301(1) $8168
[$68,541 waived]
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) $102,847, $80,933, $12,108, $1,493, $70, $5,792, $401, $14,978, $13,
$0, and $0 was paid to PDI and $141,200, $113,667, $42,438, $5,662, $9,748,
$32,170, $3,323, $25,753, $0, $0, and $6,301 was paid to CFG by the Aggressive
Growth, California Municipal Bond, Capital Income, U.S. Government Securities,
Intermediate
-81-
<PAGE> 82
Bond, Blue Chip, Asset Allocation, Flexible Income, National Municipal Bond,
Short-Term Government and International Equity Funds, respectively.
For the fiscal year ended February 28, 1997, the A Shares of
the Aggressive Growth, California Municipal Bond, Capital Income, U.S.
Government Securities, Intermediate Bond, Blue Chip, Asset Allocation, Flexible
Income, National Municipal Bond, Short-Term Government and International Equity
Funds were charged the following amounts pursuant to the Shareholder Service
Plan:
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------
Total Shareholder Amount of Total Amount of Total Amount of Total
Service Fee Shareholder Shareholder Service Shareholder Service
Service Fee Paid Fee Paid to Bank of Fee Paid to Affiliates
to CFG America of Bank of America
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Aggressive Growth Fund $516,392 $308,283 $0 $182,530
- ------------------------------------------------------------------------------------------------------------------------------
California Municipal $535,750 $205,096 $0 $303,684
Bond Fund
- ------------------------------------------------------------------------------------------------------------------------------
Capital Income Fund $677,727 $46,625 $0 $593,044
- ------------------------------------------------------------------------------------------------------------------------------
U.S. Government $202,413 $ 7,966 $0 $185,292
Securities Fund
- ------------------------------------------------------------------------------------------------------------------------------
Intermediate Bond Fund $ 40,161 $ 1,045 $0 $18,409
- ------------------------------------------------------------------------------------------------------------------------------
Blue Chip Fund $256,504 $19,012 $0 $230,703
- ------------------------------------------------------------------------------------------------------------------------------
Asset Allocation Fund $ 68,548 $ 2,735 $0 $ 64,576
- ------------------------------------------------------------------------------------------------------------------------------
Flexible Income Fund $ 77,972 $54,333 $0 $ 9,525
- ------------------------------------------------------------------------------------------------------------------------------
National Municipal Bond $ 35,033 $ 478 $0 $ 18,506
Fund [$15,738
waived]
- ------------------------------------------------------------------------------------------------------------------------------
Short-Term Government $ 12,022 $0 $0 $0
Fund [$12,022
waived]
- ------------------------------------------------------------------------------------------------------------------------------
International Equity $ 18,778 $0 $0 $0
Fund [$18,778
waived]
- ------------------------------------------------------------------------------------------------------------------------------
</TABLE>
-82-
<PAGE> 83
For the fiscal year ended February 29, 1996, the A Shares of
the Aggressive Growth, California Municipal Bond, Capital Income, U.S.
Government Securities, Intermediate Bond, Blue Chip, Asset Allocation, Flexible
Income and National Municipal Bond were charged the following amounts pursuant
to the Shareholder Service Plan:
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------
Total Shareholder Amount of Total Amount of Total Amount of Total
Service Fee Shareholder Shareholder Service Shareholder Service
Service Fee Paid Fee Paid to Bank of Fee Paid to Affiliates
to CFG America of Bank of America
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Aggressive Growth Fund $389,698 $257,687 $0 $110,825
- -----------------------------------------------------------------------------------------------------------------------------------
California Municipal Bond $511,875 $232,686 $0 $277,153
Fund
- -----------------------------------------------------------------------------------------------------------------------------------
Capital Income Fund $551,305 $ 64,707 $0 $483,153
- -----------------------------------------------------------------------------------------------------------------------------------
U.S. Government Securities $222,341 $ 17,257 $0 $205,084
Fund
- -----------------------------------------------------------------------------------------------------------------------------------
Intermediate Bond Fund $ 16,582 $ 0 $0 $ 0
[$ 16,582
waived]
- -----------------------------------------------------------------------------------------------------------------------------------
Blue Chip Fund $ 74,950 $ 0 $0 $ 0
[$ 74,950
waived]
- -----------------------------------------------------------------------------------------------------------------------------------
Asset Allocation Fund $ 33,182 $ 0 $0 $ 0
[$ 33,182
waived]
- -----------------------------------------------------------------------------------------------------------------------------------
Flexible Income Fund $ 80,246 $ 0 $0 $ 0
[$ 80,246
waived]
- -----------------------------------------------------------------------------------------------------------------------------------
National Municipal Bond $ 17,571 $ 0 $0 $ 0
Fund [$ 17,571
waived]
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
-83-
<PAGE> 84
For the fiscal year ended February 28, 1998, the SRF Shares of the Intermediate
Bond, Blue Chip, and as Asset Allocation Funds were charged the following
amounts pursuant to the Shareholder Service Plan:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------
Amount of Total Shareholder
Amount of Total Service Fee Paid to Bank of
Shareholder Service Fee America and its affiliates
Total Shareholder Paid to PDI or CFG
Service Fee
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Intermediate Bond Fund $ 62,182 $ 0 $ 55,252
[$6,406
waived]
- ---------------------------------------------------------------------------------------------------------------
Blue Chip Fund $576,234 $ 0 $ 140,129
[($436,105
waived)]
- ---------------------------------------------------------------------------------------------------------------
Asset Allocation Fund $325,357 $ 0 $ 313,527
[($11,816
waived)]
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
(1) $633, $297,583 and $11,397 was waived by PDI and $5,773, $138,252 and
$419 was waived by BISYS for the Intermediate Bond Fund, Blue Chip Fund and
Asset Allocation Fund, respectively. As of February 28, 1997, no SRF Shares had
been issued in a public offering.
Payments for shareholder service expenses under the Plans are not
subject to Rule 12b-1 (the "Rule") under the 1940 Act. Pursuant to the Plans,
the Distributor provides that a report of the amounts expended under the Plans,
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 Plans
provide that the selection and nomination of the directors of Pacific Horizon
who are not "interested persons" thereof have been committed to the discretion
of the directors who are neither "interested persons" (as defined in the 1940
Act) of Pacific Horizon nor have any direct or indirect financial interest in
the operation of the Plans (or related servicing agreements) (the
"Non-Interested Plan Directors").
Pacific Horizon 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 A or SRF 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.
Pacific Horizon's Board of Directors has concluded that the Plans
will benefit the Funds and their A and SRF shareholders. The Plans are subject
to annual reapproval by a majority of 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 A or SRF Shares of the
Fund, as the case may be, 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 the Non-Interested Plan Directors, by vote of
the holders of a majority of the A or SRF Shares of such Fund, as the case may
be, by the Distributor or by the Service Organization. Each agreement will also
terminate automatically in the event of its assignment.
-84-
<PAGE> 85
The Distribution and Services Plan, Distribution Plan and
Administrative and Shareholder Services Plan. Bank of America is entitled to
payment from the Company for distribution and service fees pursuant to the
Distribution and Services Plan adopted on behalf of the B Shares and the
Distributor is also entitled to payment for distribution fees pursuant to the
Distribution Plan adopted on behalf of K Shares. Under the Distribution and
Services Plan and Distribution Plan, the Company may pay Bank of America or the
Distributor for: (a) direct out-of-pocket promotional expenses incurred by the
Distributor in advertising and marketing B and K Shares; (b) expenses incurred
in connection with preparing, printing, mailing, and distributing or publishing
advertisements and sales literature for B and K Shares; (c) expenses incurred
in connection with printing and mailing Prospectuses and Statements of
Additional Information to other than current B and K shareholders; (d) periodic
payments or commissions to one or more securities dealers, brokers, financial
institutions or other industry professionals, such as investment advisors,
accountants, and estate planning firms (severally, "a Distribution
Organization") with respect to a Fund's B and K Shares beneficially owned by
customers for whom the Distribution Organization is the Distribution
Organization of record or holder of record of such B and K Shares; (e) the
direct or indirect cost of financing the payments or expenses included in (a)
and (d) above; or (f) for such other services as may be construed, by any court
or governmental agency or commission, including the SEC, to constitute
distribution services under the 1940 Act or rules and regulations thereunder.
With respect to K Shares, payments under the Distribution Plan are not intended
for distribution services to the extent they are not permitted under the
Employee Retirement Income Security Act of 1974, as amended.
Pursuant to the Distribution and Services Plan with respect to B
Shares and the Administrative and Shareholder Services Plan with respect to K
Shares, the Company may also pay securities dealers, brokers, financial
institutions or other industry professionals, such as investment advisors,
accountants, and estate planning firms (severally, a "Service Organization") for
support services provided with respect to its Client's B and K Shares.
Administrative and shareholder services provided may include some or all of the
following: (i) processing dividend and distribution payments from a Fund on
behalf of its Clients; (ii) providing statements periodically to its Clients
showing their positions in B and K Shares; (iii) arranging for bank wires; (iv)
responding to routine Client inquiries concerning their investment; (v)
providing the information to the Funds necessary for accounting or
sub-accounting; (vi) if required by law, forwarding shareholder communications
from a Fund (such as proxies, shareholder reports, annual and semi-annual
financial statements and dividend, distribution and tax notices) to its Clients;
(vii) aggregating and processing purchase, exchange, and redemption requests
from its Clients and placing net purchase, exchange, and redemption orders for
its Clients; (viii) establishing and maintaining accounts and records relating
to Clients; (ix) assisting Clients in changing dividend options, account
designation and addresses or (x) other similar services if requested by the
Company.
The Distribution and Services Plan provides that Bank of America
is entitled to receive payments on a monthly basis at an annual rate not
exceeding 1.00% of the average daily net assets during such month of the
outstanding B Shares. Not more than 0.25% of such net assets will be used to
compensate Service Organizations for personal services provided to B
shareholders, and/or the maintenance of such shareholders' accounts and not more
than 0.75% of such net assets of B Shares will be used for promotional and other
primary distribution activities.
The Distribution Plan provides that the Distributor is entitled to
receive payments on a monthly basis at an annual rate not exceeding 0.75% of the
average daily net assets during such month of the outstanding K Shares. In
addition, under the Administrative and Shareholder Services Plan, the
Distributor is entitled to receive payments on a monthly basis for
administrative services and shareholder services at an annual rate not exceeding
0.75% and 0.25%, respectively, of the average daily net assets during such month
of the outstanding
-85-
<PAGE> 86
K Shares. The total of all 12b-1 fees, administrative service and shareholder
service fees may not exceed, in the aggregate, the annual rate of 1.00% of the
average daily net assets of a Fund's K Shares.
Payments made out of or charged against the assets of a particular
class of shares of a particular Fund must be in payment for expenses incurred on
behalf of that class.
Payments for distribution expenses under the Distribution Plan
(the "12b-1 Plan") and Distribution and Services Plan (collectively, the "12b-1
Plans") are subject to Rule 12b-1 (the "Rule") under the 1940 Act. The Rule
defines distribution expenses to include the cost of "any activity which is
primarily intended to result in the sale of [Company] shares." The Rule
provides, among other things, that an investment company may bear such expenses
only pursuant to a plan adopted in accordance with the Rule. In accordance with
the Rule, the 12b-1 Plans provide that a written report of the amounts expended
under the 12b-1 Plans, 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 12b-1 Plans provide that it may not be amended to
increase materially the costs which a Fund may bear for distribution pursuant to
the 12b-1 Plans without shareholder approval and that other material amendments
of the 12b-1 Plans must be approved by a majority of the Board of Directors, and
by a majority 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 12b-1 Plans, or in any agreements entered into
in connection with the 12b-1 Plans, by vote cast in person at a meeting called
for the purpose of considering such amendments (the "Non-Interested Plan
Directors"). 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 Non-Interested Plan Directors.
The Company's Board of Directors has concluded that there is a
reasonable likelihood that the 12b-1 Plans and the Administrative and
Shareholder Services Plan will benefit the Funds and their B and K shareholders.
The 12b-1 Plans and the Administrative and Shareholder Services Plan are subject
to annual reapproval by a majority of the Company's Board of Directors,
including a majority of the Non-Interested Plan Directors and are terminable
without penalty at any time with respect to any Fund by a vote of a majority of
the Non-Interested Plan Directors or by vote of the holders of a majority of the
outstanding B or K Shares of the Fund involved. Any agreement entered into
pursuant to the 12b-1 Plans and the Administrative and Shareholder Services Plan
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 outstanding B or K Shares
of such Fund, or by the Service Organization. Each agreement will also terminate
automatically in the event of its assignment.
If in any month Bank of America or 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
a 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 Bank of America or
the Distributor does not expend the entire amount then available under a 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 Bank of
America or the Distributor to permit future payment. However, any unpaid amounts
or credits due under a 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, 1998, the K Shares of the
Aggressive Growth, California Municipal Bond, Capital Income, U.S. Government
Securities, Intermediate Bond, Blue Chip, Asset Allocation,
-86-
<PAGE> 87
Flexible Income, National Municipal Bond and International Equity Funds were
charged the following amounts pursuant to the Administrative and Shareholder
Service Plan:
-87-
<PAGE> 88
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------
Amount of Total
Amount of Total Administrative and
Total Administrative and Shareholder Service Fee
Administrative and Shareholder Service Fee Paid to Bank of America
Shareholder Service Fee Paid to PDI or CFG and its affiliates
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Aggressive Growth Fund $ 3,261 $ 0 $ 0
- ------------------------------------------------------------------------------------------------------------------------
California Municipal Bond Fund $ 0 $ 0 $ 0
- ---------------------------------------------------------------------------------------------------------------------
Capital Income Fund $ 4,372 $ 707(1) $ 330
- ------------------------------------------------------------------------------------------------------------------------
U.S. Government Securities Fund $ 1,534 $ 273(1) $ 0
[($485 waived)]
- ------------------------------------------------------------------------------------------------------------------------
Intermediate Bond Fund $ 1,035 $ 0(1) $ 0
[($359 waived)]
- ------------------------------------------------------------------------------------------------------------------------
Blue Chip Fund $ 8,457 $1,104(1) $ 0
- ------------------------------------------------------------------------------------------------------------------------
Asset Allocation Fund $ 2,466 $ 464(1) $ 0
[$59 waived]
- ------------------------------------------------------------------------------------------------------------------------
Flexible Income Fund $ 637 $ 144(1) $ 0
[($628 waived)]
- ------------------------------------------------------------------------------------------------------------------------
National Municipal Bond Fund $ 0 $ 0(1) $ 0
- ------------------------------------------------------------------------------------------------------------------------
International Equity Fund $ 806 $ 33(1) $ 0
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) $39 was paid to PDI with respect to the Blue Chip Fund and $707, $273,
$1,065, $464, $144 and $33 was paid to BISYS with respect to the Capital
Income, U.S. Government Securities, Blue Chip, Asset Allocation, Flexible
Income and International Equity Funds, respectively.
For the fiscal year ended February 28, 1998, the K Shares of the
Aggressive Growth, California Municipal Bond, Capital Income, U.S. Government
Securities, Intermediate Bond, Blue Chip, Asset Allocation, Flexible Income,
National Municipal Bond and International Equity Funds were charged the
following amounts pursuant to the Distribution Plan:
-88-
<PAGE> 89
<TABLE>
<CAPTION>
------------------------------------------------------------------
Total Amount of Total Amount of Total
Distribution Distribution Distribution
Plan Plan Fee Paid to PDI Plan Fee Paid
Fee or CFG to Bank of
America and
affiliates
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Aggressive Growth Fund $ 9,783 $ 690(1) $ 0
$3,261 (waived)
- -------------------------------------------------------------------------------------------------------
California Municipal Bond Fund $ 0 $ 0 $ 0
- -------------------------------------------------------------------------------------------------------
Capital Income Fund $ 13,115 $ 1,415(1) $660
[$4,372 waived]
- -------------------------------------------------------------------------------------------------------
U.S. Government Securities Fund $ 4,601 $ 544(1) $ 0
[$1,534 waived]
- -------------------------------------------------------------------------------------------------------
Intermediate Bond Fund $ 2,060 $ 462(1) $ 0
- -------------------------------------------------------------------------------------------------------
Blue Chip Fund $ 16,862 $ 2,130(1) $ 0
- -------------------------------------------------------------------------------------------------------
Asset Allocation Fund $ 4,923 $ 929(1) $ 0
- -------------------------------------------------------------------------------------------------------
Flexible Income Fund $ 1,907 $ 286(1) $ 0
[$628 waived]
- -------------------------------------------------------------------------------------------------------
National Municipal Bond Fund $ 0 $ 0 $ 0
- -------------------------------------------------------------------------------------------------------
International Equity Fund $ 2,416 $ 249(1) $ 0
[$806 waived]
- -------------------------------------------------------------------------------------------------------
</TABLE>
(1) $0, $0, $0, $0, $0, $0 and $0 was paid to PDI and $690, $1,415,
$544, $462, $2,130, $929, $286 and $249 was paid to BISYS by the Aggressive
Growth, Capital Income, U.S. Government Securities, Intermediate Bond, Blue
Chip, Asset Allocation, Flexible Income, and International Equity Funds,
respectively.
No K Shares were outstanding for the fiscal year ended February
29, 1996. As of Feburary 28, 1998, no B Shares were outstanding.
During the fiscal year ended February 28, 1997, all amounts paid
under the Distribution Plan were paid as compensation to broker/dealers.
YIELD, TAX-EQUIVALENT YIELD AND TOTAL RETURN
From time to time, the yields, tax-equivalent yield (with respect
to the National Municipal and California Municipal Bond Funds) 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
-89-
<PAGE> 90
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. 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/or a Master 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. Such advertisements or communications may include symbols, headlines or
other material which highlight or summarize the information discussed in more
detail therein. From time to time, the investment adviser may enter into
alliances with retirement plan sponsors, including The Legend Group, and the
Fund may in its advertisements or sales literature include a discussion of
certain attributes or benefits to be derived from its relationship with such
retirement plan sponsors. 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 for the respective share classes of
a Fund are 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 (including the maximum front-end sales charge
of an A 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 with respect to
a particular class is based on the average daily number of shares outstanding in
the class during the period entitled to receive dividends and includes dividends
and interest earned during the period attributable to that class minus expenses
accrued for the period attributable to that class, net of reimbursements. This
calculation can be expressed as follows:
a-b
Yield = 2 [(----- + 1)(6 power) - 1]
cd
Where: a = Dividends and interest earned during the period.
b = Expenses accrued for the period (net of
reimbursements).
c = Expenses accrued for the period (net of
reimbursements).
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
-90-
<PAGE> 91
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 Master 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
on A Shares -- currently 4.50% of the per share offering price.
The National Municipal Bond Fund's "tax-equivalent" yield for a
particular class is computed by dividing that portion of the National Municipal
Bond Fund's yield for a particular class (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 National Municipal Bond Fund's computed yield for a
particular class that is not tax-exempt. Tax-equivalent yields assume the
payment of Federal income taxes at the stated rate. The Federal income tax rate
used in calculating the National Municipal Bond Fund's tax-equivalent yield for
the 30-day period ended February 28, 1998 was 39.6%. The California Municipal
Bond Fund's "tax-equivalent" yield for a particular class is computed by: (a)
dividing the portion of the California Municipal Bond Fund's yield for a
particular class (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 California
Municipal Bond Fund's yield for a particular class (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 California Municipal Bond Fund's yield for a
-91-
<PAGE> 92
particular class that is not exempt from Federal income tax. The combined
Federal and California income tax rate used in calculating the California
Municipal Bond Fund's "tax equivalent" yield for the 30-day period ended
February 28, 1998 was 347%.
Based on the foregoing calculations, the 30-day yields of the A
Shares of the U.S. Government Securities, Capital Income, Intermediate Bond,
Asset Allocation, Short-Term Government and Flexible Income Funds (after fee
waivers and expense reimbursements) for the 30-day period ended February 28,
1998 were as follows:
<TABLE>
<CAPTION>
Yield
-----
<S> <C>
U.S. Government Securities Fund 6.50%
Capital Income Fund 2.92%
Intermediate Bond Fund 4.51%
Asset Allocation Fund 2.22%
Short-Term Government Fund 5.19%
Flexible Income Fund (Corporate Bond) 5.50%
</TABLE>
Based on the foregoing calculations, the A Shares of the
California Municipal Bond Fund's yield and tax- equivalent yield (after fee
waivers) and the A Shares of the National Municipal Bond Fund's yield and
tax-equivalent yield (after fee waivers and expense reimbursements) for the
30-day period ended February 28, 1998 were as follows:
<TABLE>
<CAPTION>
Yield Tax-Equivalent Yield
----- --------------------
<S> <C> <C>
California Municipal Bond Fund 3.79% 5.80%
National Municipal Bond Fund 4.14% 6.85%
</TABLE>
Based on the foregoing calculations, the 30-day yields of the K
Shares of the U.S. Government Securities, Capital Income, Intermediate Bond,
Asset Allocation and Flexible Income Funds (after fee waivers and expense
reimbursements) for the 30-day period ended February 28, 1998 were as follows:
<TABLE>
<CAPTION>
Yield
-----
<S> <C>
U.S. Government Securities Fund 6.36%
Capital Income Fund 2.60%
Intermediate Bond Fund 4.27%
Asset Allocation Fund 1.85%
Flexible Income Fund 5.23%
</TABLE>
-92-
<PAGE> 93
Based on the foregoing calculations, the 30-day yield of the SRF
Shares of the Intermediate Bond Fund was 4.72% and of the Asset Allocation Fund
was 2.33%
No B Shares were issued or outstanding during the 30-day period
ended February 28, 1998.
Total Return Calculations. The Funds compute their average annual
total returns separately for their separate share classes by determining the
average annual compounded rates of return during specified periods that equate
the initial amount invested in a particular share class to the ending redeemable
value of such investment in such class. 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 power)
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 separately for
their separate share classes by determining the aggregate rates of return during
specified periods that likewise equate the initial amount invested in a
particular share class to the ending redeemable value of such investment in the
class. 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
-93-
<PAGE> 94
reflect the deduction of the maximum front-end sales load charged in connection
with the purchase of A Shares and the deduction of any applicable contingent
deferred sales charge with respect to B Shares.
Based on the foregoing calculations, the 1) average annual total
returns, and 2) the aggregate total returns for the A Shares of the Aggressive
Growth, Capital Income, U.S. Government Securities, California Municipal Bond,
Intermediate Bond, Blue Chip, Asset Allocation, National Municipal Bond,
Flexible Income, Short-Term Government and International Equity Funds for the
years or periods indicated were as follows:
<TABLE>
<CAPTION>
--------------------------------------------------
Average Annual Total Returns
----------------------------------------------------------------------------------------------------------------
One-Year Five-Year Ten-Year Period from
Period Ended Period Ended Period Ended Commencement of
February 28, February 28, February 28, Operations through
1998 1998 1998 February 28, 1998*
----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Aggressive Growth Fund 17.83% 14.06% 15.86% N/A
----------------------------------------------------------------------------------------------------------------
Capital Income Fund 16.06% 14.79% 16.35% N/A
----------------------------------------------------------------------------------------------------------------
U.S. Government Securities 4.33% 4.32% 7.35% N/A
Fund (after fee waivers
----------------------------------------------------------------------------------------------------------------
California Municipal Bond 4.22% 4.89% 6.92% N/A
Fund (after fee waivers)
----------------------------------------------------------------------------------------------------------------
Intermediate Bond Fund 2.57% N/A N/A 4.35%
(after fee waivers)
----------------------------------------------------------------------------------------------------------------
Blue Chip Fund 27.92% N/A N/A 22.68%
(after fee waivers)
----------------------------------------------------------------------------------------------------------------
Asset Allocation Fund 17.55% N/A N/A 14.78%
(after fee waivers)
----------------------------------------------------------------------------------------------------------------
National Municipal Bond Fund 3.76% N/A N/A 5.40%
(fee waivers)
----------------------------------------------------------------------------------------------------------------
Flexible Income Fund 5.61% 7.10% 6.97% N/A
(after fee waivers)
----------------------------------------------------------------------------------------------------------------
International Equity Fund 5.33% N/A N/A 2.50%
(after fee waivers)
----------------------------------------------------------------------------------------------------------------
</TABLE>
- ------------------------
* The Aggressive Growth, Capital Income, U.S. Government Securities,
California Municipal Bond, Intermediate Bond, Blue Chip, Asset Allocation,
National Municipal Bond and International Equity Funds commenced operations on
March 31, 1984, September 25, 1987, January 7, 1988, March 30, 1984, January 24,
1994, January 13, 1994, January 18, 1994, January 28, 1994, and May 13, 1996,
respectively.
** Total return for the Pacific Horizon Flexible Income Fund (formerly,
Corporate Bond Fund) from 1984 through April 25, 1994 reflects performance of
the predecessor fund, Bunker Hill Income Securities, Inc., a closed-end fund.
Total return of the closed-end fund is calculated assuming a purchase of common
stock at market value on the opening of the first day of each period reported.
Total return for the closed-end fund does not reflect brokerage commissions. The
annual operating expenses of the predecessor fund were less than the
-94-
<PAGE> 95
current operating expenses of the Pacific Horizon Flexible Income Fund. Had
current expenses been reflected in the predecessor fund's performance, such
performance would have been reduced.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------------------
Aggregate Total Returns
-----------------------------------------------------------------------------------------------
One-Year Period Five-Year Ten-Year Period Period from
Ended Period Ended Ended Commencement of
February 28, February 28, February 28, Operations through
1998 1998 1998 February 28, 1998*
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Aggressive Growth Fund 17.83% 93.06% 336.02% N/A
- --------------------------------------------------------------------------------------------------------------------------------
Capital Income Fund 16.06% 99.27% 354.52% N/A
- --------------------------------------------------------------------------------------------------------------------------------
U.S. Government Securities 4.33% 23.55% 103.25% N/A
Fund (after fee waivers)
- --------------------------------------------------------------------------------------------------------------------------------
California Municipal Bond 4.22% 26.95% 95.31% N/A
Fund (after fee waivers)
- --------------------------------------------------------------------------------------------------------------------------------
Intermediate Bond Fund 2.57% N/A N/A 19.09%
(after fee waivers)
- --------------------------------------------------------------------------------------------------------------------------------
Blue Chip Fund 27.92% N/A N/A 132.68%
(after fee waivers)
- --------------------------------------------------------------------------------------------------------------------------------
Asset Allocation Fund 17.55% N/A N/A 76.38%
(after fee waivers)
- --------------------------------------------------------------------------------------------------------------------------------
National Municipal Bond 3.76% N/A N/A 24.02%
Fund (after fee waivers)
- --------------------------------------------------------------------------------------------------------------------------------
Flexible Income Fund 5.61% 40.94% 96.14% N/A
(after fee waivers)
- --------------------------------------------------------------------------------------------------------------------------------
Short-Term Government Fund 1.24% N/A N/A 4.61%
(after fee waivers)
- --------------------------------------------------------------------------------------------------------------------------------
International Equity Fund 5.33% N/A N/A 4.54%
(after fee waivers)
- --------------------------------------------------------------------------------------------------------------------------------
</TABLE>
- --------------------
* The Intermediate Bond, Blue Chip, Asset Allocation National Municipal
Bond Funds and Short-Term Government Fund commenced operations on January 24,
1994, January 13, 1994, January 18, 1994, January 28, 1994, and August 2, 1996
respectively.
** Total return for the Pacific Horizon Flexible Income Fund from 1984
through April 25, 1994 reflects performance of the predecessor fund, Bunker Hill
Income Securities, Inc., a closed-end fund. Total return of the closed-end fund
is calculated assuming a purchase of common stock at market value on the opening
of the first day of each period reported. Total return for the closed-end fund
does not reflect brokerage commissions. The annual operating expenses of the
predecessor fund were less than the current operating expenses of the Pacific
Horizon Flexible Income Fund. Had current expenses been reflected in the
predecessor fund's performance, such performance would have been reduced.
Based on the foregoing calculations, the 1) average annual total
returns, and 2) the aggregate total returns for the K Shares of the Aggressive
Growth, Capital Income, U.S. Government Securities, Intermediate Bond, Blue
Chip, Asset Allocation, Flexible Income and International Equity Funds for the
years or periods indicated were as follows:
-95-
<PAGE> 96
<TABLE>
<CAPTION>
-----------------------------------------------------
Average Annual Total Return
----------------------------------------------------------------------------------------------------
Period from
One-Year Five-Year Ten-Year Commencement of
Period Ended Period Ended Period Ended Operations**
February 28, February 28, February 28, through February
1998 1998 1998 28, 1998
----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Aggressive Growth 22.70% 14.93% 16.30% N/A
Fund*
----------------------------------------------------------------------------------------------------
Capital Income Fund* 20.97% 15.67% 16.79% N/A
----------------------------------------------------------------------------------------------------
U.S. Government 8.92% 5.18% 7.79% N/A
Securities Fund*
(after fee waivers)
----------------------------------------------------------------------------------------------------
Intermediate Bond 6.80% N/A N/A 5.35%
Fund* (after fee
waivers)
----------------------------------------------------------------------------------------------------
Blue Chip Fund* 33.08% N/A N/A 23.82%
(after fee waivers)
----------------------------------------------------------------------------------------------------
Asset Allocation Fund* 22.10% N/A N/A 15.83%
(after fee waivers)
----------------------------------------------------------------------------------------------------
Flexible Income Fund*+ 9.88% 7.94% 7.39% N/A
(after fee waivers)
----------------------------------------------------------------------------------------------------
International Equity 9.35% N/A N/A 4.46%
Fund (after fee
waivers)
----------------------------------------------------------------------------------------------------
</TABLE>
- ------------------------
* Performance prior to October 25, 1996, October 21, 1996, November 20,
1996, February 28, 1997, November 20, 1996, November 11, 1996, November 11,
1996, February 28, 1997, November 20, 1996 and October 25, 1996 is represented
by performance of the A Shares of the Aggressive Growth, Capital Income, U.S.
Government Securities, California Municipal Bond, Intermediate Bond, Blue Chip,
Asset Allocation, National Municipal Bond, Flexible Income and International
Equity Funds, respectively. On the foregoing dates, K Shares of the above-listed
Funds commenced operations. K shares, unlike A shares, are sold without a
front-end sales load but have an ongoing .75% distribution or administrative
service fee which would have reduced performance if reflected.
** The Aggressive Growth, Capital Income, U.S. Government Securities,
California Municipal Bond, Intermediate Bond, Blue Chip, Asset Allocation,
National Municipal Bond and International Equity Funds commenced operations on
March 31, 1984, September 25, 1987, January 7, 1988, March 30, 1984, January 24,
1994, January 13, 1994, January 18, 1994, January 28, 1994 and May 13, 1996,
respectively.
+ Total return for the Pacific Horizon Flexible Income (formerly, Corporate
Bond Fund) from 1984 through April 25, 1994 reflects performance of the
predecessor fund, Bunker Hill Income Securities, Inc., a closed-end fund. Total
return of the closed-end fund is calculated assuming a purchase of common stock
at market value on the opening of the first day of each period reported. Total
return for the closed-end fund does not reflect brokerage commissions. The
annual operating expenses of the predecessor fund were less than the
-96-
<PAGE> 97
current operating expenses of the Pacific Horizon Flexible Income Fund. Had
current expenses been reflected in the predecessor fund's performance, such
performance would have been reduced.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------------
Aggregate Total Returns
------------------------------------------------------------------------------------------
One-Year Period Five-Year Ten-Year Period Period from
Ended Period Ended Ended Commencement of
February 28, February 28, February 28, Operations through
1998 1998 1998 February 28, 1998
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
- ----------------------------------------------------------------------------------------------------------------------------------
Aggressive Growth Fund 22.70% 100.51% 352.84% N/A
(after fee waivers)*
- ----------------------------------------------------------------------------------------------------------------------------------
Capital Income Fund 20.97% 107.05% 372.32% N/A
*(after fee waivers)*
- ----------------------------------------------------------------------------------------------------------------------------------
U.S. Government Securities 8.92% 28.76% 111.79% N/A
Fund*(after fee waivers)*
- ----------------------------------------------------------------------------------------------------------------------------------
California Municipal Bond
Fund* (after fee waivers)* N/A**
- ----------------------------------------------------------------------------------------------------------------------------------
Intermediate Bond Fund* 6.80% N/A N/A 23.85%
(after fee waivers)*
- ----------------------------------------------------------------------------------------------------------------------------------
Blue Chip Fund* 33.08% N/A N/A 141.77%
(after fee waivers)*
- ----------------------------------------------------------------------------------------------------------------------------------
Asset Allocation Fund 22.10% N/A N/A 83.16%
(after fee waivers)**
- ----------------------------------------------------------------------------------------------------------------------------------
National Municipal Bond
Fund (after fee waivers)* N/A**
- ----------------------------------------------------------------------------------------------------------------------------------
Flexible Income Fund*+ 9.88% 46.51% 103.95% N/A
(after fee waivers)*
- ----------------------------------------------------------------------------------------------------------------------------------
International Equity Fund 9.35% N/A N/A 8.16%
(after fee waivers)*
- ----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
- --------------------
* Performance prior to October 25, 1996, October 21, 1996, November 20,
1996, February 28, 1997, November 20, 1996, November 11, 1996, November 11,
1996, February 28, 1997, November 20, 1996 and October 25, 1996 is represented
by performance of the A Shares of the Aggressive Growth, Capital Income, U.S.
Government Securities, California Tax Exempt Bond, Intermediate Bond, Blue Chip,
Asset Allocation, National Municipal Bond, Flexible Income and International
Equity Funds, respectively. On the foregoing dates, K Shares of the above-listed
Funds commenced operations. Sold without a front-end sales load but have an
ongoing .75% distribution or administrative services fee which would have
reduced price performance.
+ Total return for the Pacific Horizon Flexible Income Fund (formerly,
Corporate Bond Fund) from 1984 through April 25, 1994 reflects performance of
the predecessor fund, Bunker Hill Income Securities, Inc., a closed-end fund.
Total return of the closed-end fund is calculated assuming a purchase of common
stock at market value on the opening of the first day of each period reported.
Total return for the closed-end fund does not reflect brokerage commissions. The
annual operating expenses of the predecessor fund were less than the current
operating expenses of the Pacific Horizon Flexible Income Fund. Had current
expenses been reflected in the predecessor fund's performance, such performance
would have been reduced.
** K Shares of the California Municipal Bond and National Municipal Bond
Fund ceased operations on September 15, 1997.
-97-
<PAGE> 98
Based on the foregoing calculations, the 1) average annual total
returns, and 2) the aggregate total returns for the SRF Shares of the
Intermediate Bond, Blue Chip and Asset Allocation Funds for the years or periods
indicated were as follows:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------
Average Annual Return
- ------------------------------------------------------------------------------------------------------------------
One-Year Period Five-Year Period Period From Commencement
Ended Ended of Operations* through
February 28, 1998 February 28, 1998 February 28, 1998
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Intermediate Bond Fund 7.18% 5.05% 7.49%
(after fee waivers)*
- ------------------------------------------------------------------------------------------------------------------
Blue Chip Fund 34.32% 22.44% 17.82%
(after fee waivers)*
- ------------------------------------------------------------------------------------------------------------------
Asset Allocation Fund 23.14% 15.04% 13.26%
(after fee waivers)*
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------
Aggregate Total Return
- ------------------------------------------------------------------------------------------------------------------
One-Year Period Five-Year Period Period From Commencement
Ended Ended of Operations* through
February 28, 1998 February 28, 1998 February 28, 1998
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Intermediate Bond Fund 7.18% 27.95% 105.66%
(after fee waivers)*
- ------------------------------------------------------------------------------------------------------------------
Blue Chip Fund 34.32% 175.21% 414.17%
(after fee waivers)*
- ------------------------------------------------------------------------------------------------------------------
Asset Allocation Fund 23.14% 101.48% 246.77%
(after fee waivers)*
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
* On June 23, 1997, the Bond, Blue Chip and Asset Allocation Funds of
Seafirst Retirement Funds were reorganized into the Intermediate Bond, Blue Chip
and Asset Allocation Funds of the Company. Performance prior to June 23, 1997 is
represented by the performance of the Bond, Blue Chip and Asset Allocation of
Seafirst Retirement Funds. The Intermediate Bond, Blue Chip and Asset Allocation
Funds commenced operations on March 9, 1988.
The Funds may also advertise total return data without reflecting
sales charges in accordance with the rules of the SEC. Quotations which do not
reflect such sales charges will, of course, be higher than quotations which do.
GENERAL INFORMATION
DESCRIPTION OF SHARES
Pacific Horizon is an open-end management investment company
organized as a Maryland corporation on October 27, 1982. Pacific Horizon's
Charter authorizes the Board of Directors to issue up to four 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-one
classes of stock - Classes A through W Common Stock,
-98-
<PAGE> 99
$.001 par value per share, representing interests in twenty-one separate
investment portfolios. Class D represents interests in the A Shares of the
Aggressive Growth Fund, Class D -- Special Series 3 represents interests in the
B Shares of the Aggressive Growth Fund and Class D -- Special Series 5
represents interests in the K Shares of the Aggressive Growth Fund; Class E
represents interests in the A Shares of the U.S. Government Securities Fund,
Class E -- Special Series 3 represents interests in the B Shares of the U.S.
Government Securities Fund and Class E -- Special Series 5 represents interests
in the K Shares of the U.S. Government Securities Fund; Class F represents
interests in the A Shares of the Capital Income Fund, Class F -- Special Series
3 represents interests in the B Shares of the Capital Income Fund and Class F --
Special Series 5 represents interests in the K Shares of the Capital Income
Fund; Class G represents interests in the A Shares of the California Municipal
Bond Fund, Class G -- Special Series 3 represents interests in the B Shares of
the California Municipal Bond Fund and Class G -- Special Series 5 represents
interests in the K Shares of the California Municipal Bond Fund; Class B
represents interests in the A Shares of the Intermediate Bond Fund, Class B --
Special Series 3 represents interests in the B Shares of the Intermediate Bond
Fund; Class B -- Special Series 5 represents interests in the K Shares of the
Intermediate Bond Fund, Class B -- Special Series 7 represents interests in the
SRF Shares of the Intermediate Bond Fund; Class N represents interests in the A
Shares of the Blue Chip Fund, Class N -- Special Series 3 represents interests
in the B Shares of the Blue Chip Fund; Class N -- Special Series 5 represents
interests in the K Shares of the Blue Chip Fund and Class N -- Special Series 7
represents interests in the SRF Shares of the Blue Chip Fund; Class O represents
interests in the A Shares of the Asset Allocation Fund, Class O -- Special
Series 3 represents interests in the B Shares of the Asset Allocation Fund;
Class O -- Special Series 5 represents interests in the K Shares of the Asset
Allocation Fund and Class O -- Special Series 7 represents interests in the SRF
Shares of the Asset Allocation Fund; Class Q represents interests in the A
Shares of the National Municipal Bond Fund, Class Q -- Special Series 3
represents interests in the B Shares of the National Municipal Bond Fund and
Class Q -- Special Series 5 represents interests in the K Shares of the National
Municipal Bond Fund; Class T represents interests in the A Shares of the
International Equity Fund, Class T -- Special Series 3 represents interests in
the B Shares of the International Equity Fund and Class T -- Special Series 5
represents interests in the K Shares of the International Equity Fund; Class U
represents interests in the A Shares of the Short-Term Government Fund, Class U
- - Special Series 3 represents interests in the B Shares of the Short-Term
Government Fund and Class U - Special Series 5 represents interests in the K
Shares of the Short-Term Government Fund; Class W represents interests in the A
Shares of the Flexible Income Fund, Class W -- Special Series 3 represents
interests in the B Shares of the Flexible Income Fund and Class W -- Special
Series 5 represents interests in the K Shares of the Flexible Income Fund.
Pacific Horizon's charter also authorizes the Board of Directors to classify or
reclassify any particular class of Pacific Horizon'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, Pacific Horizon's shares will be fully
paid and non-assessable. For information concerning possible restrictions upon
the transferability of Pacific Horizon'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.
-99-
<PAGE> 100
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 Pacific Horizon 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
Pacific Horizon voting without regard to particular Funds.
Notwithstanding any provision of Maryland law requiring a greater
vote of Pacific Horizon'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 Pacific
Horizon's Charter, Pacific Horizon may take or authorize such action upon the
favorable vote of the holders of more than 50% of the outstanding common stock
of Pacific Horizon voting without regard to class.
THE MASTER PORTFOLIOS
The Intermediate Bond Master Portfolio and Blue Chip Master
Portfolio are separate series of Master Investment Trust, Series I. 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 Master Portfolios are entitled to distributions arising from
the net investment income and net realized gains, if any, earned on investments
held by the Master Portfolio. Investors are also entitled to participate in the
net distributable assets of the Master Portfolio in which they hold beneficial
interests on liquidation. Beneficial interests have no preemptive rights,
conversion or exchange rights.
REPORTS
Shareholders will receive unaudited semi-annual reports describing
the Master Portfolio's and Funds' investment operations and annual financial
statements together with the reports of the independent accountants of the
Funds.
CUSTODIAN, ACCOUNTING AGENT AND TRANSFER AGENT
The Bank of New York, 90 Washington Street, New York, New York
10286, has been appointed custodian for the Non- Feeder Funds except the
Flexible Income Fund, International Equity Fund and Asset Allocation Fund. PNC
Bank, National Association, 1600 Market Street, Philadelphia, PA 19103 has been
appointed custodian for the Blue Chip Fund, Intermediate Bond Fund, Flexible
Income Fund, International Equity Fund, Asset Allocation Fund, Intermediate Bond
Master Portfolio and Blue Chip Master Portfolio. The Bank of New York (with
respect to the National Municipal Bond Fund, California Municipal Bond Fund,
U.S. Government Securities Fund, Capital Income Fund and Aggressive Growth Fund)
and PFPC (with respect to the Flexible Income Fund, International Equity Fund,
Short-Term Government Fund, Asset Allocation Fund, Intermediate Bond Fund and
Blue Chip Fund) provide the Funds with certain accounting services pursuant to
Fund Accounting Services Agreements with Bank of America. Both PFPC, which is
located at 103 Bellevue
-100-
<PAGE> 101
Parkway, Wilmington, DE 19809, and PNC Bank, National Association are wholly
owned subsidiaries of PNC Bancorp, Inc., a bank holding company. Under separate
Fund Accounting Services Agreements, The Bank of New York and PFPC have agreed
to provide certain accounting, bookkeeping, pricing, dividend and distribution
calculation services with respect their respective Funds. The monthly fees
charged by The Bank of New York and PFPC under the Fund Accounting Agreements
are borne by the Funds. As custodians, The Bank of New York and PNC Bank, N.A.
each (i) maintain separate account or accounts in the name of the respective
Funds and/or Master Portfolios, as appropriate (ii) hold and disburse portfolio
securities; (iii) make receipts and disbursements of money, (iv) collect and
receive income and other payments and distributions on account of portfolio
securities, (v) respond to correspondence from security brokers and others
relating to their respective duties and (vi) make periodic reports concerning
their duties.
PFPC Inc., P.O. Box 8968, Wilmington, Delaware 19899-8968, serves
as transfer and dividend disbursing agent for each class of shares of the Funds.
COUNSEL
Drinker Biddle & Reath LLP (of which Mr. McConnel, Secretary of
Pacific Horizon, is a partner), 1345 Chestnut Street, Philadelphia, PA
19107 serves as counsel to the Companies and will pass upon the legality of the
shares offered hereby. O'Melveny & Meyers acts as counsel to Bank of America and
as special California counsel for the California Municipal Bond Fund and has
reviewed the portions of the California Municipal 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.
INDEPENDENT ACCOUNTANTS
PricewaterhouseCoopers LLP, representing the combined firms of
Price Waterhouse LLP and Coopers & Lybrand L.L.P., independent accountants, with
offices at 1177 Avenue of the Americas, New York, New York, has been selected as
independent accountants of each Fund for the fiscal year ended February 28,
1999.
FINANCIAL STATEMENTS AND EXPERTS
The Annual Reports for each Fund for their fiscal year ended
February 28, 1998 (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 appears in each Annual Report and is also incorporated herein by reference.
No other parts of the Annual Report are incorporated by reference herein. 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.
MISCELLANEOUS
As used in the Prospectuses and this Statement of Additional
Information, a "vote of a majority" of the outstanding shares or interests of a
Fund, a Master Portfolio or a particular series means the affirmative vote of
the lesser of (a) more than 50% of the outstanding shares or interests of such
Fund, Master Portfolio or series or (b) 67% of the shares or interests of such
Fund, Master Portfolio or series present at a meeting at which
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<PAGE> 102
more than 50% of the outstanding shares or interests of such Fund, Master
Portfolio or series are represented in person or by proxy.
PRINCIPAL HOLDERS OF SECURITIES
As of June 5, 1998, the officers and directors of the Company collectively owned
less than 1% of the outstanding shares of any class of the Funds.
As of June 5, 1998, the following entities were known by the Funds to own 5% or
more of the outstanding shares of any class of the Funds:
<TABLE>
<CAPTION>
PERCENT OF
NUMBER OF OUTSTANDING
SHARES HELD SHARES OF CLASS
-------------------- ---------------
<S> <C> <C>
PRIME FUND -- PACIFIC HORIZON SHARES
BA Investment Services, Inc. 2,112,267,667.780 80.6%
</TABLE>
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<PAGE> 103
<TABLE>
<S> <C> <C>
FBO Customers
Unit 17852
P.O. Box 7042
San Francisco, CA 94120
BancAmerica Robertson Stephens 259,888,898.200 9.9%
FBO Customers
Unit 17852
P.O. Box 7042
San Francisco, CA 94120
PRIME FUND -- HORIZON SHARES
Bank of America NT&SA 815,409,324.970 31.3%
Private Bank
Attn: Common Trust Funds Unit 38329
P.O. Box 513577
Terminal Annex
Los Angeles, CA 90051
William Barron Hilton 311,526,000.000 11.9%
Charitable Remainder Trust
9336 Civic Center Drive
Beverly Hills, CA 90210
PRIME FUND -- HORIZON SERVICE SHARES
Bank of America NT&SA 934,160,388.770 25.0%
Financial Management and Trust Services
P.O. Box 513577 -- Terminal Annex
Los Angeles, CA 90051
BA Investment Services, Inc. 310,996,075.190 8.3%
FBO Customers
Unit 17852
P.O. Box 7042
San Francisco, CA 94120
Security Pacific Cash Management 708,728,100.000 19.0%
c/o Bank of America
1850 Gateway Blvd.
Concord, CA 94520
PRIME FUND -- X SHARES
BA Investment Services, Inc. 528,249,277.05 50.9%
FBO Customers
Unit 17852
</TABLE>
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<PAGE> 104
<TABLE>
<S> <C> <C>
P.O. Box 7042
San Francisco, CA 94120
PRIME FUND -- Y SHARES
BA Arizona 8,049,762.200 5.5%
2044 Franklin Street
Oakland, CA 94612
Bank of America-California 7,500,000.000 5.1%
2044 Franklin Street
Oakland, CA 94612
Karsten Manufacturing Corporation 8,149,580.350 5.6%
2201 West Desert Cove
Phoenix, AZ 85029
PRIME FUND -- S SHARES
BA Investment Services, Inc. 803,285,361.970 99.2%
FBO Customers
Unit 17852
P.O. Box 7042
San Francisco, CA 94120
TREASURY FUND -- PACIFIC HORIZON SHARES
HARE & Co., Bank of New York 64,553,129.890 20.9%
and Short Term Investment Funds
One Wall Street
New York, NY 10286
BA Investment Services, Inc. 192,584,335.900 62.4%
FBO Customers
Unit 17852
P.O. Box 7042
San Francisco, CA 94120
TREASURY FUND -- HORIZON SHARES
Bank of America NT&SA 227,462,997.510 32.4%
Private Banking
Attn: Trust Funds Unit 38329
P.O. Box 513577
Terminal Annex
Los Angeles, CA 90051
HARE & Co 164,326,526.330 23.4%
c/o Bank of New York
</TABLE>
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<PAGE> 105
<TABLE>
<S> <C> <C>
One Wall Street, 5th Floor
New York, NY 10286
KPMG Peat Marwick LLP 51,000,000.000 7.3%
3 Chestnut Ridge Road
Montvale, NJ 07645
Los Angeles Department of Airports 42,557,369.150 6.1%
515 South Flower Street
Los Angeles, CA 90071
Century Theatres Inc. 47,096,226.750 6.7%
150 Pelican Way
San Rafael, CA 94901
TREASURY FUND -- HORIZON SERVICE SHARES
Security Pacific Cash Management 199,484,100.000 11.3%
c/o Bank of America
1850 Gateway Blvd.
Concord, CA 94520
Bank of America FM&TS 368,064,376.550 20.8%
Attn: Common Trust Funds Unit 38329
P.O. Box 513577
Terminal Annex
Los Angeles, CA 90051
TREASURY FUND -- X SHARES
BA Investment Services, Inc. 12,694,320.760 5.3%
FBO Customers
Unit 17852
P.O. Box 7042
San Francisco, CA 94120
Bank of America California 32,000,000.000 13.5%
2044 Franklin Street
Oakland, CA 94612
TREASURY FUND -- Y SHARES
Bank of America California 5,000,000.000 6.6%
2044 Franklin Street
Oakland, CA 94612
BA Arizona 7,700,404.480 10.2%
2044 Franklin Street
</TABLE>
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<PAGE> 106
<TABLE>
<S> <C> <C>
Oakland, CA 94612
BA Nevada 6,071,336.580 8.0%
2044 Franklin Street
Oakland, CA 94612
CCC TA Welfare Benefit Trust 5,736,144.850 7.6%
2950 E. Rochelle Ave
Las Vegas, NV 89121
Collectron AZ 4,051,866.650 5.4%
P.O. Box 1931
Nogales, AZ 85628
Sunclipse Inc. 4,191,584.710 5.6%
6600 Valley View Street
Buena Park, CA 90620
TREASURY ONLY FUND -- PACIFIC HORIZON SHARES
HARE & Co., Bank of New York and Short 22,854,225.010 12.1%
Term Investment Funds
One Wall Street
New York, NY 10286
BA Investment Services, Inc. 101,186,129.680 53.4%
FBO Customers
Unit 17852
P.O. Box 7042
San Francisco, CA 94120
BancAmerica Robertson Stephens 59,850,049.120 31.6%
FBO Customers
Unit 17852
P.O. Box 7042
San Francisco, CA 94120
TREASURY ONLY FUND -- HORIZON SHARES
Bank of America Illinois 4,334,149.550 13.6%
231 S. LaSalle Street
Chicago, IL 60697
Bank of America NT&SA 22,854,051.990 71.5%
Attn: Common Trust Funds Unit 38329
P.O. Box 513577
Terminal Annex
</TABLE>
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<PAGE> 107
<TABLE>
<S> <C> <C>
Los Angeles, CA 90051
City and County of San Francisco 4,100,243.250 12.8%
Mayors Office of Community
25 Van Ness Avenue, Suite 700
San Francisco, CA 94102
TREASURY ONLY FUND -- HORIZON SERVICE SHARES
Bank of America NT&SA 52,896,546.290 24.3%
Attn: Common Trust Funds Unit 38329
P.O. Box 513577
Terminal Annex
Los Angeles, CA 90051
BA Investment Services, Inc. 17,371,255.110 8.0%
FBO Customers
P.O. Box 7042
San Francisco, CA 94120
The Emerson U. and Erika J. Glazer Trust 12,364,024.280 5.7%
3 Del Amo Fashion Center
Torrance, CA 90503
GOVERNMENT -- PACIFIC HORIZON SHARES
Wall Data Inc. 14,657,467.680 9.2%
11332 NE 122nd Way
Kirkland, WA 98034
HARE & Co., Bank of New York and Short 8,707,595.120 5.5%
Term Investment Funds
One Wall Street
New York, NY 10286
BA Investment Services, Inc. 93,865,900.070 59.1%
FBO Customers
Unit 17852
P.O. Box 7042
San Francisco, CA 94120
BancAmerica Robertson Stephens 24,813,941.710 15.6%
FBO Customers
P.O. Box 7042
San Francisco, CA 94120
GOVERNMENT FUND -- HORIZON SHARES
</TABLE>
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<PAGE> 108
<TABLE>
<S> <C> <C>
Skinner Corporation 11,294,088.600 5.1%
1326 Fifth Avenue, Suite 711
Seattle, WA 98101
New York New York Hotel LLC 12,847,712.880 5.8%
3790 Las Vegas Boulevard South
Las Vegas, NV 89109
Sletton Construction of Nevada Inc. 12,607,585.140 5.7%
P.O. Box 93776
Las Vegas, NV 89193
GOVERNMENT FUND -- HORIZON SERVICE SHARES
Bank of America NT&SA 35,965,540.250 80.6%
Trust, Financial Management & Trust Services
Attn: Common Trust Funds Unit 38329
P.O. Box 513577
Terminal Annex
Los Angeles, CA 90051
Security Pacific Cash Management 6,619,300.000 14.8%
c/o Bank of America
1850 Gateway Blvd
Concord, CA 94520
TAX EXEMPT MONEY FUND -- PACIFIC HORIZON SHARES
BA Investment Services, Inc. 124,277,308.400 94.6%
FBO Customers Unit 17852
P.O. Box 7042
San Francisco, CA 94120
TAX EXEMPT MONEY FUND -- HORIZON SHARES
Bank of America NT&SA 308,877,964.040 94.5%
The Private Bank
P.O. Box 513577
Terminal Annex
Los Angeles, CA 90051
TAX EXEMPT MONEY FUND -- HORIZON SERVICE SHARES
BA Investment Services, Inc. 29,904,479.330 11.5%
FBO Customers
Unit 17852
P.O. Box 7042
San Francisco, CA 94120
</TABLE>
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<PAGE> 109
<TABLE>
<S> <C> <C>
Bank of America 117,932,621.380 65.1%
Attn: Common Trust Funds Unit 38329
P.O. Box 513577
Terminal Annex
Los Angeles, CA 90051
TAX EXEMPT MONEY FUND -- S SHARES
BA Investment Services, Inc. 35,815,756.430 100.0%
FBO Customers
P.O. Box 7042
San Francisco, CA 94120
CALIFORNIA TAX-EXEMPT MONEY MARKET FUND
-- PACIFIC HORIZON SHARES
BA Investment Services, Inc. 300,327,896.900 54.2%
FBO Customers
Unit 17852
P.O. Box 7042
San Francisco, CA 94120
BancAmerica Robertson Stephens 232,178,555.240 41.9%
FBO Customers
Unit 17852
P.O. Box 7042
San Francisco, CA 94120
CALIFORNIA TAX-EXEMPT MONEY MARKET FUND
-- HORIZON SERVICE SHARES
Bank of America NT&SA 326,393,595.930 55.0%
Attn: Common Trust Funds Unit
P.O. Box 513577
Terminal Annex
Los Angeles, CA 90051
BA Investment Services, Inc. 175,398,911.420 29.6%
FBO Customers
Unit 17852
P.O. Box 7042
San Francisco, CA 94120
CALIFORNIA TAX-EXEMPT MONEY MARKET FUND
-- X SHARES
BA Investment Services, Inc. 25,836,568.320 100.0%
FBO Customers
Unit 17852
P.O. Box 7042
</TABLE>
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<PAGE> 110
<TABLE>
<S> <C> <C>
San Francisco, CA 94120
CALIFORNIA TAX EXEMPT MONEY MARKET FUND
-- S SHARES
BA Investment Services, Inc. 227,376,082.980 100.0%
FBO Customers
Unit 17852
P.O. Box 7042
San Francisco, CA 94120
INTERMEDIATE BOND FUND -- A SHARES
PACO -- Attn: Mutual Funds 544,191.036 12.1%
P.O. Box 513577
Los Angeles, CA 90051
Bank of America NT&SA 2,347,781.402 52.2%
The Private Bank
Attn: Common Trust Funds Unit 38329
P.O. Box 3577
Terminal Annex
Los Angeles, CA 90051
PACO 475,408.464 10.6%
P.O. Box 513577
Los Angeles, CA 90051
INTERMEDIATE BOND FUND -- K SHARES
Corelink Financial, Inc. 46,135.414 100.0%
P.O. Box 4054
Concord, CA 94524
INTERMEDIATE BOND FUND -- SRF SHARES
Seafirst Bank 3,080,718.572 100.0%
FBO Retirement Services
P.O. Box 84248
Seattle, WA 98124
CORPORATE BOND FUND -- A SHARES
PACO 206,707.063 8.1%
Attn: Mutual Funds
P.O. Box 513577
Los Angeles, CA 90051
Bank of America NT&SA 477,339.651 18.8%
The Private Bank
Attn: Common Trust Funds Unit 38329
</TABLE>
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<PAGE> 111
<TABLE>
<S> <C> <C>
P.O. Box 3577
Terminal Annex
Los Angeles, CA 90051
FLEXIBLE INCOME (FORMERLY CORPORATE BOND) FUND -- K SHARES
Corelink Financial, Inc. 23,543.085 100.0%
P.O. Box 4054
Concord, CA 94524
U.S. GOVERNMENT SECURITIES FUND -- K SHARES
Corelink Financial, Inc. 116,153.211 100.0%
P.O. Box 4054
Concord, CA 94524
SHORT-TERM GOVERNMENT FUND -- A SHARES
Bank of America NT&SA 3,156,142.163 83.8%
The Private Bank
Attn: Common Trust Funds Unit 38329
P.O. Box 3577
Terminal Annex
Los Angeles, CA 90051
CALIFORNIA MUNICIPAL (FORMERLY, CALIFORNIA
TAX-EXEMPT) BOND FUND -- A SHARES
Bank of America NT&SA 3,044,994.685 9.6%
The Private Bank
Attn: Common Trust Funds Unit 38329
P.O. Box 3577
Terminal Annex
Los Angeles, CA 90051
CAPITAL INCOME FUND -- K SHARES
Corelink Financial, Inc. 150,245.252 88.5%
P.O. Box 4054
Concord, CA 94524
ASSET ALLOCATION FUND -- A SHARES
Corelink Financial, Inc. 260,091.341 8.1%
P.O. Box 4054
Concord, CA 94524
Bank of America NT&SA 272,916.571 8.5%
FBO PACO
Attn: Mutual Funds Unit
P.O. Box 3577
Terminal Annex
</TABLE>
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<PAGE> 112
<TABLE>
<S> <C> <C>
Los Angeles, CA 90051
Vanguard Fiduciary Trust Company 184,535.325 5.8%
Kirkland and Ellis Defined
Contribution Retirement Plan
P.O. Box 2600
Valley Forge, PA 19482
ASSET ALLOCATION FUND -- K SHARES
Corelink Financial, Inc. 63,480.863 100.0%
P.O. Box 4054
Concord, CA 94524
ASSET ALLOCATION -- SRF SHARES
Seafirst Bank 11,668,940.795 100.0%
FBO Retirement Services
P.O. Box 84248
Seattle, WA 98124
AGGRESSIVE GROWTH FUND - A SHARES
PACO - Attn: Mutual Funds 491,251.531 5.3%
P.O. Box 513577
Los Angeles, CA 90051
AGGRESSIVE GROWTH FUND -- K SHARES
Corelink Financial Inc. 161,757.766 100.0%
P.O. Box 4054
Concord, CA 94524
BLUE CHIP FUND -- A SHARES
Bank of America NT&SA 901,809.695 7.6%
The Private Bank
Attn: Common Trust Funds Unit 38329
P.O. Box 513577
Terminal Annex
Los Angeles, CA 90051
BLUE CHIP FUND -- K SHARES
Corelink Financial Inc. 250,051.579 99.5%
P.O. Box 4054
Concord, CA 94524
BLUE CHIP FUND -- SRF SHARES
Seafirst Bank 13,956,166.970 100.0%
FBO Retirement Services
P.O. Box 84248
</TABLE>
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<PAGE> 113
<TABLE>
<S> <C> <C>
Seattle, WA 98124
INTERNATIONAL EQUITY FUND -- A SHARES
PACO 789,867.260 18.9%
Attn: Mutual Funds
P.O. Box 513577
Los Angeles, CA 90051
Bank of America NT&SA 893,038.660 21.3%
The Private Bank
Attn: Common Trust Funds Unit 38329
P.O. Box 3577
Terminal Annex
Los Angeles, CA 90051
PACO 1,500,976.246 35.9%
Attn: Mutual Funds
P.O. Box 513577
Los Angeles, CA 90051
INTERNATIONAL EQUITY FUND -- K SHARES
Corelink Financial, Inc. 62,528.613 100.0%
P.O. Box 4054
Concord, CA 94524
</TABLE>
At June 5, 1998, 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.
As of July 1, 1998, Bank of America and its affiliates held of record
approximately 97.26%, 88.51%, 50.53%, 97.52%, 83.82%, 95.79%, 95.63%, 98.31%,
66.43%, 58.83%, 74.91%, 99.74%, 48.26%, 57.77%, 30.81%, 87.50% and 74.72% of
the outstanding shares of the International Equity, U.S. Government Securities,
Flexible Income (formerly Corporate Bond), Intermediate Bond, Capital Income,
Blue Chip, Asset Allocation, National Municipal Bond, California Municipal Bond
(formerly California Tax-Exempt Bond), Treasury, Prime, Short-Term Government,
Aggressive Growth, California Tax-Exempt Money Market, Tax-Exempt Money,
Government, and Treasury Only Funds, respectively, as agent or custodian for
their customers.
The Prospectuses and this SAI 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 SEC by
paying the charges prescribed under its rules and regulations.
FINANCIAL STATEMENTS
The Annual Reports for each Fund for their fiscal year ended February 28, 1998
accompany this SAI. The financial statements and notes thereto in each Annual
Report are incorporated into this
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<PAGE> 114
APPENDIX A
COMMERCIAL PAPER RATINGS
A Standard & Poor's ("S&P") commercial paper rating is a
current assessment of the likelihood of timely payment of debt having an
original maturity of no more than 365 days. The following summarizes the rating
categories used by Standard and Poor's for commercial paper:
"A-1" - Obligations are rated in the highest category
indicating that the obligor's capacity to meet its financial commitment is
strong. Within this category, certain obligations are designated with a plus
sign (+). This indicates that the obligor's capacity to meet its financial
commitment on these obligations is extremely strong.
"A-2" - Obligations are somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than
obligations rated "A-1". However, the obligor's capacity to meet its financial
commitment on the obligation is satisfactory.
"A-3" - Obligations exhibit adequate protection parameters.
However, adverse economic conditions or changing circumstances are more likely
to lead to a weakened capacity of the obligor to meet its financial commitment
on the obligation.
"B" - Obligations are regarded as having significant
speculative characteristics. The obligor currently has the capacity to meet its
financial commitment on the obligation; however, it faces major ongoing
uncertainties which could lead to the obligor's inadequate capacity to meet its
financial commitment on the obligation.
"C" - Obligations are currently vulnerable to nonpayment and
are dependent on favorable business, financial, and economic conditions for the
obligor to meet its financial obligation.
"D" - Obligations are in payment default. The "D" rating
category is used when payments on an obligation are not made on the date due,
even if the applicable grace period has not expired, unless S&P believes such
payments will be made during such grace period. The "D" rating will also be used
upon the filing of a bankruptcy petition or the taking of a similar action if
payments on an obligation are jeopardized.
Moody's commercial paper ratings are opinions of the ability
of issuers to repay punctually senior debt obligations not having an original
maturity in excess of one year, unless explicitly noted. The following
summarizes the rating categories used by Moody's for commercial paper:
"Prime-1" - Issuers (or supporting institutions) have a
superior ability for repayment of senior short-term debt obligations. Prime-1
repayment ability will often be evidenced by many of the following
characteristics: leading market positions in well-established industries; high
rates of return on funds employed; conservative capitalization structure with
moderate reliance on debt and ample asset protection; broad margins
A-1
<PAGE> 115
in earnings coverage of fixed financial charges and high internal cash
generation; and well-established access to a range of financial markets and
assured sources of alternate liquidity.
"Prime-2" - Issuers (or supporting institutions) have a strong
ability for repayment of senior short-term debt obligations. This will normally
be evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, may be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternate liquidity is maintained.
"Prime-3" - Issuers (or supporting institutions) have an
acceptable ability for repayment of senior short-term debt obligations. The
effect of industry characteristics and market compositions may be more
pronounced. Variability in earnings and profitability may result in changes in
the level of debt protection measurements and may require relatively high
financial leverage. Adequate alternate liquidity is maintained.
"Not Prime" - Issuers do not fall within any of the Prime
rating categories.
The three rating categories of Duff & Phelps 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 the highest certainty of timely
payment. Short-term liquidity, including internal operating factors and/or
access to alternative sources of funds, is outstanding, and safety is just below
risk-free U.S.
Treasury short-term obligations.
"D-1" - Debt possesses very high certainty of timely payment.
Liquidity factors are excellent and supported by good fundamental protection
factors. Risk factors are minor.
"D-1-" - Debt possesses high certainty of timely payment.
Liquidity factors are strong and supported by good fundamental protection
factors. Risk factors are very small.
"D-2" - Debt possesses good certainty of timely payment.
Liquidity factors and company fundamentals are sound. Although ongoing funding
needs may enlarge total financing requirements, access to capital markets is
good. Risk factors are small.
"D-3" - Debt possesses satisfactory liquidity and other
protection factors qualify issues as investment grade. Risk factors are larger
and subject to more variation. Nevertheless, timely payment is expected.
"D-4" - Debt possesses speculative investment characteristics.
Liquidity is not sufficient to insure against disruption in debt service.
Operating factors and market access may be subject to a high degree of
variation.
"D-5" - Issuer has failed to meet scheduled principal and/or
interest payments.
A-2
<PAGE> 116
Fitch IBCA short-term ratings apply to debt obligations that
have time horizons of less than 12 months for most obligations, or up to three
years for U.S. public finance securities. The following summarizes the rating
categories used by Fitch IBCA for short-term obligations:
"F1" - Securities possess the highest credit quality. This
designation indicates the strongest capacity for timely payment of financial
commitments and may have an added "+" to denote any exceptionally strong credit
feature.
"F2" - Securities possess good credit quality. This
designation indicates a satisfactory capacity for timely payment of financial
commitments, but the margin of safety is not as great as in the case of
securities rated "F1".
"F3" - Securities possess fair credit quality. This
designation indicates that the capacity for timely payment of financial
commitments is adequate; however, near-term adverse changes could result in a
reduction to non-investment grade.
"B" - Securities possess speculative credit quality. this
designation indicates minimal capacity for timely payment of financial
commitments, plus vulnerability to near-term adverse changes in financial and
economic conditions.
"C" - Securities possess high default risk. This designation
indicates that the capacity for meeting financial commitments is solely reliant
upon a sustained, favorable business and economic environment.
"D" - Securities are in actual or imminent payment default.
Thomson BankWatch short-term ratings assess the likelihood of
an untimely payment of principal and interest of debt instruments with original
maturities of one year or less. The following summarizes the ratings used by
Thomson BankWatch:
"TBW-1" - This designation represents Thomson BankWatch's
highest category and indicates a very high likelihood that principal and
interest will be paid on a timely basis.
"TBW-2" - This designation represents Thomson BankWatch's
second-highest category and indicates that while the degree of safety regarding
timely repayment of principal and interest is strong, the relative degree of
safety is not as high as for issues rated "TBW-1."
"TBW-3" - This designation represents Thomson BankWatch's
lowest investment-grade category and indicates that while the obligation is more
susceptible to adverse developments (both internal and external) than those with
higher ratings, the capacity to service principal and interest in a timely
fashion is considered adequate.
A-3
<PAGE> 117
"TBW-4" - This designation represents Thomson BankWatch's
lowest rating category and indicates that the obligation is regarded as
non-investment grade and therefore speculative.
CORPORATE AND MUNICIPAL LONG-TERM DEBT RATINGS
The following summarizes the ratings used by Standard & Poor's
for corporate and municipal debt:
"AAA" - An obligation rated "AAA" has the highest rating
assigned by Standard & Poor's. The obligor's capacity to meet its financial
commitment on the obligation is extremely strong.
"AA" - An obligation rated "AA" differs from the highest rated
obligations only in small degree. The obligor's capacity to meet its financial
commitment on the obligation is very strong.
"A" - An obligation rated "A" is somewhat more susceptible to
the adverse effects of changes in circumstances and economic conditions than
obligations in higher rated categories. However, the obligor's capacity to meet
its financial commitment on the obligation is still strong.
"BBB" - An obligation rated "BBB" exhibits adequate protection
parameters. However, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity of the obligor to meet its financial
commitment on the obligation.
"BB," "B," "CCC," "CC" and "C" - Debt is regarded as having
significant speculative characteristics. "BB" indicates the least degree of
speculation and "C" the highest. While such obligations will likely have some
quality and protective characteristics, these may be outweighed by large
uncertainties or major exposures to adverse conditions.
"BB" - Debt is less vulnerable to non-payment than other
speculative issues. However, it faces major ongoing uncertainties or exposure to
adverse business, financial or economic conditions which could lead to the
obligor's inadequate capacity to meet its financial commitment on the
obligation.
"B" - Debt is more vulnerable to non-payment than obligations
rated "BB", but the obligor currently has the capacity to meet its financial
commitment on the obligation. Adverse business, financial or economic conditions
will likely impair the obligor's capacity or willingness to meet its financial
commitment on the obligation.
"CCC" - Debt is currently vulnerable to non-payment, and is
dependent upon favorable business, financial and economic conditions for the
obligor to meet its financial commitment on the obligation. In the event of
adverse business, financial or economic conditions, the obligor is not likely to
have the capacity to meet its financial commitment on the obligation.
"CC" - An obligation rated "CC" is currently highly vulnerable
to non-payment.
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<PAGE> 118
"C" - The "C" rating may be used to cover a situation where a
bankruptcy petition has been filed or similar action has been taken, but
payments on this obligation are being continued.
"D" - An obligation rated "D" is in payment default. This
rating is used when payments on an obligation are not made on the date due, even
if the applicable grace period has not expired, unless S & P believes that such
payments will be made during such grace period. "D" rating is also used upon the
filing of a bankruptcy petition or the taking of similar action if payments on
an obligation are jeopardized.
PLUS (+) OR MINUS (-) - The ratings from "AA" through "CCC"
may be modified by the addition of a plus or minus sign to show relative
standing within the major rating categories.
"r" - This 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 absence of an "r"
symbol should not be taken as an indication that an obligation will exhibit no
volatility or variability in total return.
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.
"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 are considered as medium-grade obligations,
(i.e., they are neither highly protected nor poorly secured). Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
"Ba," "B," "Caa," "Ca," and "C" - Bonds that possess one of
these ratings provide questionable protection of interest and principal ("Ba"
indicates speculative elements; "B" indicates a general lack of characteristics
of desirable investment; "Caa" are of poor standing; "Ca" represents obligations
which are
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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.
Note: Those bonds in the Aa, A, Baa, Ba and B groups which
Moody's believes possess the strongest investment attributes are designated by
the symbols, Aa1, A1, Baa1, Ba1 and B1.
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 ratings used by Fitch IBCA for
corporate and municipal bonds:
"AAA" - Bonds considered to be investment grade and of the
highest credit quality. These ratings denote the lowest expectation of
investment risk and are assigned only in case of exceptionally strong capacity
for timely payment of financial commitments. This capacity is very unlikely to
be adversely affected by foreseeable events.
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<PAGE> 120
"AA" - Bonds considered to be investment grade and of very
high credit quality. These ratings denote a very low expectation of investment
risk and indicate very strong capacity for timely payment of financial
commitments. This capacity is not significantly vulnerable to foreseeable
events.
"A" - Bonds considered to be investment grade and of high
credit quality. These ratings denote a low expectation of investment risk and
indicate strong capacity for timely payment of financial commitments. This
capacity may, nevertheless, be more vulnerable to adverse changes in
circumstances or in economic conditions than bonds with higher ratings.
"BBB" - Bonds considered to be investment grade and of good
credit quality. These ratings denote that there is currently a low expectation
of investment risk. The capacity for timely payment of financial commitments is
adequate, but adverse changes in circumstances and in economic conditions are
more likely to impair this category.
"BB" - Bonds considered to be speculative. These ratings
indicate that there is a possibility of credit risk developing, particularly as
the result of adverse economic changes over time; however, business or financial
alternatives may be available to allow financial commitments to be met.
Securities rated in this category are not investment grade.
"B" - Bonds are considered highly speculative. These ratings
indicate that significant credit risk is present, but a limited margin of safety
remains. Financial commitments are currently being met; however, capacity for
continued payment is contingent upon a sustained, favorable business and
economic environment.
"CCC", "CC", "C" - Bonds have high default risk. Capacity for
meeting financial commitments is reliant upon sustained, favorable business or
economic developments. "CC" ratings indicate that default of some kind appears
probable, and "C" ratings signal imminent default.
"DDD," "DD" and "D" - Bonds are in default. Securities are not
meeting obligations and are extremely speculative. "DDD" designates the highest
potential for recovery on these securities, and "D" represents the lowest
potential for recovery.
To provide more detailed indications of credit quality, the
Fitch IBCA ratings from and including "AA" to "B" may be modified by the
addition of a plus (+) or minus (-) sign to show relative standing within these
major rating categories.
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 extremely high.
"AA" - This designation indicates a very strong ability to
repay principal and interest on a timely basis with limited incremental risk
compared to issues rated in the highest category.
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<PAGE> 121
"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 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 a strong
capacity to pay principal and interest. Those issues determined to possess very
strong characteristics are given a plus (+) designation.
"SP-2" - The issuers of these municipal notes exhibit
satisfactory capacity to pay principal and interest, with some vulnerability to
adverse financial and economic changes over the term of the notes.
"SP-3" - The issuers of these municipal notes exhibit
speculative capacity to pay principal and interest.
Moody's ratings for state and municipal notes and other
short-term loans are designated Moody's Investment Grade ("MIG") and variable
rate demand obligations are designated Variable Moody's Investment Grade
("VMIG"). Such ratings recognize the differences between short-term credit risk
and long-term risk. The following summarizes the ratings by Moody's Investors
Service, Inc. for short-term notes:
"MIG-1"/"VMIG-1" - This designation denotes best quality,
enjoying strong protection by established cash flows, superior liquidity support
or demonstrated broad-based access to the market for refinancing.
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<PAGE> 122
"MIG-2"/"VMIG-2" - This designation denotes high quality, with
margins of protection ample although not so large as in the preceding group.
"MIG-3"/"VMIG-3" - This designation denotes favorable quality,
with all security elements accounted for but lacking the undeniable strength of
the preceding grades. Liquidity and cash flow protection may be narrow and
market access for refinancing is likely to be less well established.
"MIG-4"/"VMIG-4" - This designation denotes adequate quality,
carrying specific risk but having protection commonly regarded as required of an
investment security and not distinctly or predominantly speculative.
"SG" - This designation denotes speculative quality and lack
of margins of protection.
Fitch IBCA 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 Funds, 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.
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
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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 a 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. Such 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 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
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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 a 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 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 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 fund,
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. 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
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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 National Municipal Bond Fund will sell index futures
contracts in order to offset a decrease in market value of its fund securities
that might otherwise result from a market decline. The Fund 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 National Municipal Bond Fund will purchase index futures
contracts in anticipation of purchases of securities. In a substantial majority
of these transactions, the National Municipal Bond Fund 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 National Municipal Bond Fund'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 National Municipal Bond Fund is paid the difference and
thus realizes a gain. If the offsetting purchase price exceeds the sale price,
the National Municipal Bond Fund pays the difference and realizes a loss.
Similarly, the closing out of a futures contract purchase is effected by the
National Municipal Bond 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 National Municipal
Bond Fund 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>
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>
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The current value of the fund is $5,003,750.
To hedge against a decline in the value of the fund, 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:
Ohio HFA 81-28
NYS Power 98-26
San Diego, CA IDB 98-11
Muscatine, IA Elec 99-24
Mass Health & Ed 97-18
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.
<TABLE>
<CAPTION>
Cash Market Futures Market
----------- --------------
<S> <C> <C>
February 2 $5,003,750 long position in Sell 50 municipal Bond futures
municipal bonds contracts at 86-09
March 23 $4,873,438 long position in Buy Municipal Bond futures
municipal bonds contracts at 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.
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III. 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.
The Aggressive Growth Fund, Capital Income Fund, Blue Chip
Master Fund, Asset Allocation Fund and International Equity 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, Capital Income Fund,
Blue Chip Fund, Asset Allocation Fund and International Equity 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 Aggressive Buying 1 Index Futures at 125
with Growth Fund 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/Contract
Increase in Purchase Price = $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 Aggressive Sell 16 Index Futures at 125
Growth Fund Value of Futures = $1,000,000
- Day Hedge is Lifted
Aggressive Growth Fund - Own Stock Buy 16 Index Futures at 120
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 Aggressive Buying 1 Index Futures at 125
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/Contract
Decrease in Purchase Price = $2,500 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 Aggressive Sell 16 Index Futures at 125
Growth Fund Value of Futures = $1,000,000
- Day Hedge is Lifted
Aggressive Growth Fund - Own Stock Buy 16 Index Futures at 130
with Value = $1,040,000 Value of Futures = $1,040,000
Gain in Fund Value = $40,000 Loss of Futures = $40,000
</TABLE>
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IV. 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.
V. 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 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.
VI. 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
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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 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 collateralized 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 investment adviser may
still not result in a successful hedging transaction over a short time frame.
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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 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.
VII. 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
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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 Fund because the
maximum amount at risk is the premium paid for the options (plus transaction
costs).
VIII. OTHER HEDGING TRANSACTIONS
The U.S. Government Securities Capital Income, Blue Chip,
Intermediate Bond, Asset Allocation and International Equity Funds presently
intend to use interest rate futures contracts, the Aggressive Growth, the Blue
Chip, Asset Allocation and International Equity Funds presently intend to use
stock index futures contract (and foreign currency futures contracts (and
related options) with respect to the Aggressive Growth and International Equity
Funds) 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
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.
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