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AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JUNE 7, 1996
FILE NO. 2-84920
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT UNDER
THE SECURITIES ACT OF 1933
POST-EFFECTIVE AMENDMENT NO. 22
(CHECK APPROPRIATE BOX OR BOXES)
/X/
REGISTRATION STATEMENT UNDER
THE INVESTMENT COMPANY ACT OF 1940
AMENDMENT NO. 23
/X/
SBSF FUNDS, INC.
(Exact Name of Registrant as Specified in Charter)
45 Rockefeller Plaza
New York, New York 10111
(Address of Principal Executive Offices)(Zip Code)
Registrant's Telephone Number, including Area Code: (212) 903-1255
Leigh A. Wilson
45 Rockefeller Plaza
New York, New York 10111
(Name and Address of Agent for Service)
COPIES TO:
Michael R. Parker, Esq. Robert M. Kurucza, Esq.
Spears, Benzak, Salomon & Farrell, Inc. Marco E. Adelfio, Esq.
45 Rockefeller Plaza Morrison & Foerster LLP
New York, NY 10111 2000 Pennsylvania Ave., NW
Washington, DC 20006
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It is proposed that this filing will become effective (check appropriate box)
<TABLE>
<S> <C>
immediately upon filing pursuant to Rule 485(b), on (date) pursuant to Rule 485(b),
or or
60 days after filing pursuant to Rule 485(a)(1), on (date) pursuant to Rule 485(a)(1),
or or
/X/ 75 days after filing pursuant to Rule 485(a)(2), on (date) pursuant to paragraph (a)(2)
or of Rule 485
</TABLE>
If appropriate, check the following box:
this post-effective amendment designates a new effective date for a
previously filed post-effective amendment.
No filing fee is required under the Securities Act of 1933 because an indefinite
number of shares of the Registrant's Common Stock, par value $.01 per share, has
previously been registered pursuant to Rule 24f-2 under the Investment Company
Act of 1940. The Registrant filed the notice required by Rule 24f-2 on January
29, 1996 for its fiscal year ended November 30, 1995.
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EXPLANATORY NOTE
This Post-Effective Amendment No. 22 to the Registration Statement (the
"Amendment") of SBSF Funds, Inc. (the "Company") is being filed to register
three new series: Key Growth Fund, Key Moderate Growth Fund and Key
Conservative Growth Fund (collectively, the "Funds"). Each of the Funds will
invest substantially all of its assets in proprietary and non-proprietary
mutual funds (the "Underlying Portfolios") as a "fund of funds", pursuant to a
pending application for an exemptive order that would permit such investments
(Application File No. 812-10164). This Amendment does not affect the
Registration Statement for the Company's SBSF Fund, SBSF Money Market Fund,
SBSF Convertible Securities Fund, and SBSF Capital Growth Fund, or the
Registration Statement for the Company's Key Stock Index Fund and Key
International Index Fund.
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CROSS REFERENCE SHEET
(AS REQUIRED BY RULE 495)
<TABLE>
<CAPTION>
N-1A ITEM NO. LOCATION
- ------------- --------
<S> <C> <C>
PART A PART A
Item 1. Cover Page Cover Page
Item 2. Synopsis Fund Expenses
Item 3. Condensed Financial Information Not Applicable
Item 4. General Description of Registrant Description of Common Stock; Investment Objectives and Policies;
Descriptions of Proprietary Portfolios;
Item 5. Management of the Fund Management of the Funds; Expenses, Distribution Plan and Shareholder
Servicing Plan
Item 5A. Management's Discussion of Fund
Performance Not Applicable
Item 6. Capital Stock and Other Securities Description of Common Stock; Shareholder Reports; Dividends,
Distributions and Federal Income Taxes
Item 7. Purchase of Securities Being
Offered Expenses, Distribution Plan and Shareholder Servicing Plan;
Determination of Net Asset Value; Purchasing Shares; Investing for
Retirement; The Systematic Investment Plan; The Systematic
Withdrawal Plan; Exchange Privileges; Performance
Item 8. Redemption or Repurchase Redeeming Shares
Item 9. Pending Legal Proceedings Not Applicable
PART B PART B
Item 10. Cover Page Cover Page
Item 11. Table of Contents Table of Contents
Item 12. General Information and History Other Information
Item 13. Investment Objectives and Policies Investment Objectives and Policies; Investment Restrictions of the
Funds; Portfolio Turnover; Appendix
Item 14. Management of the Fund Management of the Funds
Item 15. Control Persons and Principal
Holders of Securities Not Applicable
Item 16. Investment Advisory and Other
Services The Investment Adviser of the Funds; Expenses, Distributor and
Distribution Plan;
</TABLE>
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<TABLE>
<S> <C>
Shareholder Servicing Plan; Custodian, Transfer Agent and Dividend
Disbursing Agent; Independent Accountants and Reports; Counsel
Item 17. Brokerage Allocation and
Other Practices Portfolio Transactions and Brokerage
Item 18. Capital Stock and Other Securities Other Information
Item 19. Purchase, Redemption and Pricing
of Securities Being Offered Purchase, Redemption and Pricing
Item 20. Tax Status Federal Income Taxes
Item 21. Underwriters Expenses, Distributor and Distribution Plan
Item 22. Calculation of Performance Data Performance Information
Item 23. Financial Statements Independent Accountants and Reports
</TABLE>
PART C
Information required to be included in Part C is set forth under the appropriate
Item, so numbered in Part C to this Registration Statement.
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PROSPECTUS
KEY MUTUAL FUNDS
45 ROCKEFELLER PLAZA
NEW YORK, NEW YORK 10111
Key Mutual Funds, formerly known as SBSF Funds, Inc., (the "Company") is a
professionally managed, open end, series investment company currently consisting
of several different portfolios, three of which (collectively, the "Funds") are
described in this Prospectus. Each Fund is a separately managed diversified
portfolio with its own investment objective and policies. The Funds have no
sales charges, redemption fees or exchange fees.
Each Fund has been constructed as a "fund of funds," which means that it pursues
its investment objective primarily by allocating its investments among other
mutual funds (the "Underlying Portfolios"). The Underlying Portfolios include
portfolios of Key Mutual Funds (sometimes "KMF") and The Victory Portfolios
(sometimes "VP") (collectively, the "Proprietary Portfolios") as well as
portfolios that are not affiliated with the Funds (the "Other Portfolios"). See
"Investment Objectives and Policies" below for a more complete discussion.
KeyCorp Mutual Fund Advisers, Inc. (the "Adviser" or "KMFA"), an indirect wholly
owned subsidiary of KeyCorp, serves as investment adviser to each of the Funds.
As of March 31, 1996, KMFA and its affiliates managed approximately $66 billion
for numerous clients including large corporate and public retirement plans,
Taft-Hartley plans, foundations and endowments, high net worth individuals and
mutual funds.
The Funds were created to provide investors with experienced, professional
investment management and personal service and to take advantage of certain
risk-spreading benefits derived from investing in other mutual funds. The
investor should be aware of the higher expenses and certain potential tax
implications associated with an investment in a "fund of funds." See "Expenses,
Distribution Plan and Shareholder Servicing Plan" and "Dividends, Distribution
and Federal Income Taxes" for a more complete discussion.
KEY GROWTH FUND
The investment objective of the Key Growth Fund ("Growth Fund") is to
seek to provide growth of capital. The Growth Fund seeks to achieve its
objective by allocating its assets primarily among Underlying Portfolios that
invest in stocks.
KEY MODERATE GROWTH FUND
The investment objective of the Key Moderate Growth Fund ("Moderate
Growth Fund") is to seek to provide growth of capital combined with a moderate
level of current income. The Moderate Growth Fund seeks to achieve its
objective by allocating its assets among Underlying Portfolios that invest in
stocks and, to a lesser extent, fixed income securities.
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KEY CONSERVATIVE GROWTH FUND
The investment objective of the Key Conservative Growth Fund
("Conservative Growth Fund") is to seek to provide current income combined with
moderate growth of capital. The Conservative Growth Fund seeks to achieve its
objective by allocating its assets among Underlying Portfolios that invest in
fixed income securities and, to a lesser extent, stocks.
SHARES OF THE FUNDS ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR
ENDORSED BY, KMFA, KEYCORP, ANY OF THEIR AFFILIATES, OR ANY OTHER BANK AND ARE
NOT FEDERALLY INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION (FDIC), THE
FEDERAL RESERVE BOARD OR ANY OTHER AGENCY. AN INVESTMENT IN MUTUAL FUND SHARES
IS SUBJECT TO INVESTMENT RISKS, INCLUDING THE POSSIBLE LOSS OF THE PRINCIPAL.
This Prospectus sets forth concisely the information about the Funds that a
prospective investor should know before investing. Additional information about
the Funds has been filed with the Securities and Exchange Commission in a
Statement of Additional Information dated [AUGUST __, 1996], as supplemented
from time to time, which is incorporated herein by reference and is available
without charge upon request by writing or calling the Funds at 800-539-3863.
Investors are advised to read and retain this Prospectus for future reference.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
The date of this Prospectus is [AUGUST , 1996]
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TABLE OF CONTENTS
<TABLE>
<S> <C>
Fund Expenses 4
Investment Objectives and Policies 6
Descriptions of Proprietary Portfolios 13
- Performance of Proprietary Portfolios
- Description of Underlying Key Mutual Funds
- Description of Underlying Victory Portfolios
Management of the Funds 18
- Directors and Officers
- The Investment Adviser
- The Administrator, Distributor and Fund Accountant
Expenses, Distribution Plan and Shareholder Servicing Plan 20
Determination of Net Asset Value 22
Purchasing Shares 22
The Systematic Investment Plan 25
The Systematic Withdrawal Plan 25
Redeeming Shares 26
Exchange Privileges 28
Investing For Retirement 30
Dividends, Distributions and Federal Income Taxes 30
Performance 33
Description of Common Stock 33
Custodian, Transfer Agent and Dividend Disbursing Agent 34
Shareholder Reports 34
</TABLE>
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FUND EXPENSES
EXPENSES ARE ONE OF SEVERAL FACTORS TO CONSIDER WHEN INVESTING IN THE FUNDS. THE
FOLLOWING TABLE SUMMARIZES SHAREHOLDER TRANSACTION EXPENSES AND OPERATING
EXPENSES FOR THE FUNDS.
<TABLE>
<CAPTION>
KEY KEY
KEY MODERATE CONSERVATIVE
GROWTH GROWTH GROWTH
FUND FUND FUND
---- ---- ----
<S> <C> <C> <C>
Shareholder Transaction Expenses:
Maximum sales load imposed on purchases None None None
Maximum sales load imposed on reinvested
dividends None None None
Deferred sales load None None None
Redemption Fees None None None
Exchange Fees None None None
Annual Fund Operating Expenses:
(as a percentage of average daily net assets)
Management Fees .15% .15% .15%
Other Expenses (after waivers and reimbursements)(1) .25% .25% .25%
--- --- ---
Total Fund Operating Expenses (after waivers and
reimbursements)(2) .40% .40% .40%
</TABLE>
(1) "Other Expenses" includes estimates of such expenses as administrative
fees, shareholder servicing fees, custodial and transfer agency fees,
audit, legal and other business expenses for the current fiscal year.
Absent voluntary fee waivers and expense reimbursements, "Other
Expenses" are estimated to be [ %] for each Fund. Absent voluntary
waivers, the shareholder servicing fee alone is estimated to be a
maximum of .25% of average daily net assets of each Fund.
(2) Absent fee waivers and/or expense reimbursements described in Note 1
above, "Total Fund Operating Expenses" are estimated to be [ %] for
the Key Growth Fund, [ %] for the Key Moderate Growth Fund, and
[ %] for the Key Conservative Growth Fund.
The purpose of this table is to assist an investor in understanding the various
costs and expenses that an investor in the Funds will bear directly (Shareholder
Transaction Expenses) or indirectly (Annual Fund Operating Expenses). There can
be no assurance that the foregoing voluntary fee waivers and/or expense
reimbursements will continue. For a more complete description of the Funds'
operating expenses, see "Expenses, Distribution Plan and Shareholder Servicing
Plan."
Shareholders in the Funds will bear indirectly the expenses of the Proprietary
Portfolios in which the Funds are expected to invest. The following tables
provide the expense ratios for each of the Proprietary Portfolio investments for
its 1995 fiscal year as well as the estimated percentage range of each Fund's
net assets that could be invested in each Proprietary Portfolio.
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<TABLE>
<CAPTION>
PERCENTAGE PERCENTAGE OF
EXPENSE PERCENTAGE OF MODERATE CONSERVATIVE
RATIOS OF GROWTH GROWTH GROWTH
(AFTER FUND'S FUND'S FUND'S
PROPRIETARY PORTFOLIO WAIVERS) NET ASSETS NET ASSETS NET ASSETS
--------------------- -------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
KEY MUTUAL FUNDS:
SBSF Fund 1.26% [0% TO __] [0% TO __] [0% TO __]
SBSF Convertible Securities
Fund 1.31%
SBSF Capital Growth Fund 1.20%
VICTORY PORTFOLIOS:
Value Fund 1.40%
Diversified Stock Fund* 1.05%
Growth Fund 1.40%
Special Value Fund* 1.45%
Special Growth Fund 1.53%
International Growth Fund* 1.70%
Limited Term Income Fund .86%
Ohio Regional Stock Fund 1.45%
Investment Quality Bond Fund 1.00%
Fund for Income 1.00%
Financial Reserves Fund .65%
</TABLE>
*Denotes Class A shares only.
Based on these figures, the average weighted expense ratios for the
Funds' investments in the Proprietary Portfolios would be __% for the Growth
Fund, __% for the Moderate Growth Fund and __% for the Conservative Growth Fund.
These figures are approximations of the Funds' underlying expense ratios for the
Proprietary Portfolios only. The Funds' underlying expense ratios for the Other
Portfolios may be higher or lower than these expense ratios. The assets of the
Funds invested in each of the Proprietary Portfolios will vary within the ranges
shown above, and a portion of the assets of the Funds may be invested in Other
Portfolios that are not included in these figures.
Using the average weighted expense ratios shown above for each Fund,
the following example demonstrates the projected dollar amount of total
cumulative expenses, at both the Fund level and the Underlying Portfolio level,
that would be incurred over various periods with respect to each of the Funds.
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KEY KEY
KEY MODERATE CONSERVATIVE
GROWTH GROWTH GROWTH
FUND FUND FUND
---- ---- ----
Example
- -------
You would pay the following expenses on a $1,000
investment, assuming (1) a 5% annual return and
(2) full redemption at the end of each time period:
1 Year
3 Years
THIS EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE
EXPENSES AND ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN. MOREOVER,
WHILE THE TABLE ASSUMES A 5% ANNUAL RETURN, A FUND'S ACTUAL PERFORMANCE WILL
VARY AND MAY RESULT IN AN ACTUAL RETURN GREATER OR LESS THAN 5%. YOU WOULD PAY
THE SAME AMOUNT OF EXPENSES ON THE SAME INVESTMENT ASSUMING NO REDEMPTION AT THE
END OF EACH TIME PERIOD.
INVESTMENT OBJECTIVES AND POLICIES
There are three Key Personal Choice Portfolios: Conservative Growth
Fund, Moderate Growth Fund, and Growth Fund. These three portfolios invest in up
to [__] Key or Victory Portfolios Fund mutual funds representing different
combinations of stocks, bonds or cash reserves, each having varying degrees of
potential investment risk and reward. In addition, non-affiliated funds ("Other
Portfolios") may be used to fulfill a particular investment niche. Each
portfolio will be managed based on the investment restrictions and asset
allocation policies described in this prospectus. An investor would choose a
portfolio based on personal objectives, investment time horizon, tolerance for
risk and personal financial circumstances.
As a general matter, the Funds invest between 80% and 85% of their
assets in investment portfolios of KMF and VP. The remainder of each Fund's
assets is invested primarily in shares of Other Portfolios, which are not part
of the same group of investment companies as the Funds. Initial and subsequent
allocation decisions are made as a result of investment analyses undertaken by
the Investment Adviser within the ranges shown below.
The Funds are intended as an efficient and cost-effective method of
allowing investors access to a comprehensive allocation program. The risk/return
balance of each individually managed Fund can be varied by altering the
proportion of assets allocated to different types of investments. For example,
an investor seeking higher growth potential generally would invest a larger
portion of assets in stocks while an investor seeking less volatility generally
would invest a larger portion of assets in high-quality bonds or cash
equivalents. This asset allocation approach is the fundamental principle behind
the Funds.
The Funds do not pay a front-end sales load or contingent deferred
sales charge in connection with the purchase or redemption of shares of the
Underlying Portfolios. Furthermore, any sales charges or service fees associated
with the purchase of shares of the Funds will not exceed the limits set forth in
the National Association of Securities Dealers, Inc. (the "NASD") Rules of Fair
Practice when aggregated with any sales charges or service fees that the Funds
pay relating to Proprietary Portfolio shares.
The investment objectives and policies of each of the three Funds are
set forth below.
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KEY GROWTH FUND
The investment objective of the Growth Fund is to seek to provide
growth of capital. The Growth Fund seeks to achieve this objective by allocating
its assets primarily among Underlying Portfolios that invest in stocks.
The Growth Fund selects appropriate Proprietary Portfolios and Other
Portfolios in which to invest based on the direction of the Investment Adviser,
KMFA. KMFA continuously monitors the allocation and rebalances and reallocates
its investments across Underlying Portfolios as market conditions warrant. All
reallocations are expected to occur within the ranges shown below. As shown
below, the Growth Fund maintains an investment mix of 70-90% of its assets in
Underlying Portfolios that invest in equity securities, 10-30% of its assets in
Underlying Portfolios that invest in bonds and fixed income securities and 0-15%
of its assets in Underlying Portfolios that invest in money market instruments.
KEY MODERATE GROWTH FUND
The investment objective of the Moderate Growth Fund is to seek to
provide growth of capital combined with a moderate level of current income. The
Moderate Growth Fund seeks to achieve this objective by allocating its assets
among Underlying Portfolios that invest in stocks and, to a lesser extent,
fixed income securities.
The Moderate Growth Fund selects appropriate Proprietary Portfolios and
Other Portfolios in which to invest based on the direction of the Investment
Adviser, KMFA. KMFA continuously monitors the allocation and rebalances and
reallocates its investments across Underlying Portfolios as market conditions
warrant. All reallocations are expected to occur within the ranges shown below.
As shown below, the Moderate Growth Fund maintains an investment mix of 50-70%
of its assets in Underlying Portfolios that invest in equity securities, 30-50%
of its assets in Underlying Portfolios that invest in bonds and fixed-income
securities, and 0-15% of its assets in Underlying Portfolios that invest in
money market instruments.
KEY CONSERVATIVE GROWTH FUND
The investment objective of the Conservative Growth Fund is to seek to
provide current income combined with moderate growth of capital. The
Conservative Growth Fund seeks to achieve this objective by allocating its
assets among Underlying Portfolios that invest in fixed income securities and,
to a lesser extent, stocks.
The Conservative Growth Fund selects appropriate Proprietary Portfolios
and Other Portfolios in which to invest based on the direction of the Investment
Adviser, KMFA. KMFA continuously monitors the allocation and rebalances and
reallocates its investments across Underlying Portfolios as market conditions
warrant. All reallocations are expected to occur within the ranges shown below.
As shown below, the Conservative Growth Fund maintains an investment mix of
30-50% of its assets in Underlying Portfolios that invest in income-producing
equity securities, 50-70% of its assets in Underlying Portfolios that invest in
bonds and fixed-income securities, and 0-15% of its assets in Underlying
Portfolios that invest in money market instruments.
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The following table shows how the Growth Fund, Moderate Growth Fund and
Conservative Growth Fund's assets are divided among various types of Underlying
Portfolios:
<TABLE>
<CAPTION>
Percentage of
Percentage of Percentage of Conservative
Growth Fund's Moderate Growth Growth Fund's Proprietary Portfolios
Investment Category Net Assets Fund's Net Assets Net Assets Qualifying for Purchase
- ------------------- ---------- ----------------- ---------- -----------------------
<S> <C> <C> <C> <C>
Equity Funds 70-90% 50-70% 30-50% SBSF Fund
SBSF Capital Growth Fund
Value Fund
Diversified Stock Fund
Growth Fund
Special Value Fund
Special Growth Fund
Ohio Regional Stock Fund
International Growth Fund
Bond/Fixed Income Funds 10-30% 30-50% 50-70% SBSF Convertible Securities Fund
Limited Term Income Fund
Investment Quality Bond Fund
Fund for Income
Money Market Funds 0-15% 0-15% 0-15% Financial Reserves Fund
</TABLE>
ALL FUNDS
The selection of the Proprietary Portfolios in which the Growth Fund,
Moderate Growth Fund and Conservative Growth Fund will invest, as well as the
percentage of assets which can be invested in each type of underlying mutual
fund, are not fundamental investment policies and can be changed without the
approval of a majority of the respective Fund's shareholders. Any change to the
percentage ranges shown above for allocation across types of Underlying
Portfolios requires the approval of the Company's Board of Directors. Any change
to the percentage ranges shown above for allocation to Proprietary Portfolios as
contrasted with Other Portfolios also requires the approval of the Company's
Board of Directors. Investors desiring more information on a Proprietary
Portfolio listed above may call Key Mutual Funds and Victory Portfolios at
800-539-3863 to request a prospectus, which is available without charge. The
selection of the specific Other Portfolios is within the Adviser's discretion.
Changes in the value of the Underlying Portfolios may affect cash
income, if any, derived from these investments and will affect a Fund's net
asset value (NAV). Because each Fund invests primarily in other mutual funds,
which fluctuate in value, the Funds' shares will correspondingly fluctuate in
value. Although the Funds normally seek to remain substantially fully invested
in the Underlying Portfolios, a Fund may invest temporarily in certain
short-term obligations. Such obligations may be used to invest uncommitted cash
balances or to maintain liquidity to meet shareholder redemptions. A Fund also
may borrow money for temporary or emergency purposes.
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INVESTMENT ADVISORY CONFLICTS OF INTEREST
The Investment Adviser and certain of its affiliates provide advisory
and other services to the Proprietary Portfolios, for which they receive
compensation. The level of compensation may vary among the Proprietary
Portfolios. In addition, although the Investment Adviser and certain of its
affiliates may provide services to, and receive fees from, the Other Portfolios,
any fees received from Other Portfolios are likely to be substantially less than
those received from the Proprietary Portfolios. Fees received from Other
Portfolios are also likely to vary. These fee differences subject the Investment
Adviser to conflicts of interest, in that the Investment Adviser could increase
its fee income or that of its affiliates by allocating Fund assets to Underlying
Portfolios that pay higher fees.
In addition, the Investment Adviser is subject to conflicts of interest
in selecting Other Portfolios and in deciding on the percentage of Fund assets
to allocate to Other Portfolios, as contrasted with Proprietary Portfolios.
Although the Investment Adviser will have the authority to select Other
Portfolios and to make changes to the Other Portfolios purchased by the Funds,
any decision to replace an Other Portfolio with a Proprietary Portfolio, or to
reduce the proportion of assets allocated to Other Portfolios below 15% (at time
of purchase) will require the approval of the Board of Directors of the Company,
including a majority of the Directors who are not interested persons of the
Company. These restrictions are intended to reduce, in part, these conflicts of
interest. However, they will not eliminate them, as the Directors may also have
conflicting interests in fulfilling their fiduciary duties to the Funds and the
Proprietary Portfolios.
In selecting Underlying Portfolios, the Investment Adviser is not
required to select portfolios on the basis of any specific criteria, such as
prior performance. Rather, the Investment Adviser has the discretion to select
Underlying Portfolios, including both Proprietary and Other Portfolios, based on
various factors that it deems relevant under the circumstances. Accordingly, an
Underlying Portfolio may underperform relative to the universe of funds within a
category of funds (e.g., Short-Term Bond Funds).
PERMISSIBLE INVESTMENTS AND ASSOCIATED RISKS
In addition to the Underlying Portfolios, the Growth Fund, Moderate
Growth Fund and Conservative Growth Fund may each invest in high quality
short-term debt obligations, bankers' acceptances, certificates of deposit,
commercial paper, obligations issued or guaranteed by the U.S. Government, its
agencies and instrumentalities, and demand and time deposits of domestic and
foreign banks and savings and loan associations.
INVESTMENT COMPANY SECURITIES. An exemptive order issued by the
Securities and Exchange Commission (the "Commission") permits: (a) the Funds to
purchase an unlimited amount of the outstanding voting shares of each
Proprietary Portfolio; (b) the securities of each Proprietary Portfolio to have
an aggregate value of as much as 100% of the total assets of the Funds; (c) the
Funds to invest up to 100% of their assets in the securities of the Proprietary
Portfolios; and (d) each of the Proprietary Portfolios to sell more than 3% of
its total outstanding voting stock to the Funds under certain conditions.
Without this order, the Investment Company
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Act of 1940, as amended (the "1940 Act") would prohibit to a great degree any
investing by the Funds in the Proprietary Portfolios. Because such other
investment companies employ an investment adviser, investments by a Fund in
shares of Underlying Portfolios will cause shareholders to bear additional fees,
such as management fees, to the extent advisory fees are not waived by KMFA. The
Key Mutual Funds are advised by Spears, Benzak, Salomon & Farrell, Inc.
("Spears") or KMFA and the Victory Portfolios are advised by KMFA. See
"Expenses, Distribution Plan and Shareholder Servicing Plan" for a more complete
discussion of expenses.
The Funds may invest between 15% and 20% of their respective assets in
mutual funds that are not part of the same group of investment companies as the
Funds (i.e., the Other Portfolios) based on their conformance with the
investment objectives of the Funds and the Investment Adviser's judgment. Such
investment is constrained by federal securities regulations in that a Fund and
its affiliates, collectively, may acquire no more than 3% of the total
outstanding stock of any Other Portfolio. Under the 1940 Act, an Other Portfolio
may elect not to redeem shares in excess of 1% of its outstanding shares during
any period of less than thirty days. Accordingly, if a Fund and its affiliates
were to accumulate over 1%, but less than 3%, of an Other Portfolio's
outstanding stock, the Investment Adviser may have difficulty disposing of it.
In order to avoid that possible liquidity problem, the Investment Adviser
continually monitors each Fund's holdings with respect to the percentage of each
Other Portfolio's shares purchased. In light of the foregoing legal constraints
on buying and selling stocks of the Other Portfolios, investors should realize
that occasions may arise when the Investment Adviser might not take advantage of
certain opportunities to invest in these portfolios, and may in fact seek
suitable alternatives. Some Other Portfolios may elect to redeem their shares
wholly or in part in portfolio securities in lieu of cash as part of an
"in-kind" redemption, which has certain expenses associated with it. If a Fund
receives securities as part of an in-kind redemption, the Fund will receive and
retain the securities (or immediately liquidate such securities) if the
Investment Adviser believes that it is in the best interest of shareholders,
whether or not the purchase of such securities would have been permitted by the
investment objectives and policies of the Fund. It is important to note that the
Funds have little or no knowledge or control over the daily investment
activities and management of these Other Portfolios. Investments in Other
Portfolios will be limited to an aggregate value not in excess of twenty percent
(20%) of the value of the total assets of the Fund at the time of purchase. KMFA
will select the Other Portfolios that may be purchased from time to time by the
Funds.
Depending on an Other Portfolio's investment objective, policies and
restrictions, additional risks may be created by a Fund's investment in an Other
Portfolio. Other Portfolio's may follow some or all of the investment practices
of the Proprietary Portfolios and may follow other investment practices. The
Funds have little or no control over the investment activities of the Other
Portfolios. There may, in fact, be additional investment practices, not
discussed herein or in the Statement of Additional Information, that both the
Proprietary Portfolios and Other Portfolios may engage in from time to time.
A Fund may invest in a mutual fund that concentrates (invests at least
25% of its assets) its investments within one industry. Because the scope of
investment alternatives within an industry may be limited, the value of shares
of such fund may be subject to greater market
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fluctuation than an investment in a mutual fund which has a diversified
portfolio. The Funds may be impacted indirectly by such a concentration policy.
A Fund is permitted to invest in a mutual fund that invests in
derivatives, such as options, future contracts, and options on future contracts.
In general, a derivative is a financial instrument, the value of which is based
on, or "derived" from, another security. For a more complete discussion of
derivatives and their special risks, see "Investment Objectives and Policies" in
the Statement of Additional Information.
The Funds do not pay any front-end sales loads or contingent deferred
sales charges in connection with the purchase or redemption of shares of the
Proprietary Portfolios. The asset-based sales charges or service fees associated
with purchase of shares of the Funds will not exceed the limits set forth in
Article III, Section 26, of the NASD Rules of Fair Practice when aggregated with
any asset-based sales charges or service fees that the Funds pay relating to
Proprietary Portfolio shares.
Although some of the Underlying Portfolios in which the Funds invest do
not necessarily share the same investment objective as the investing Fund,
those Underlying Portfolios will be selected by the Investment Adviser based on
various criteria. Among other things, the Investment Adviser analyzes the
potential portfolio's investment objective, policies, and investment strategy
to see how it compares to that of the Fund. Performance is also evaluated,
along with strength of management, size, and portfolio composition.
An investor in the Funds should realize that he or she may invest
directly in the Underlying Portfolios and that by investing in the Underlying
Portfolios indirectly through the Funds, he or she will bear not only his or her
proportionate share of the expenses of the Funds (including operating costs and
investment advisory, shareholder servicing and administrative fees), but also,
indirectly, similar expenses of the Underlying Portfolios. The Board of
Directors of the Company has determined that the advisory fees payable to KMFA
under the advisory contracts of the Funds are for services that are in addition
to, rather than duplicative of, services provided pursuant to any underlying
mutual fund's advisory contract. See "Expenses, Distribution Plan and
Shareholder Servicing Plan" for a more complete discussion of expenses. The
Proprietary Portfolios and Other Portfolios themselves may incur distribution
plan expenses in the form of "12b-1 fees."
INVESTMENT RISKS
CERTAIN INVESTMENT TECHNIQUES. Every investment in a mutual fund
involves some risk and an investment in the Funds is no different in that
respect. These Funds are designed to help spread risk and even out swings in
performance through a comprehensive allocation program of investing in several
Underlying Portfolios. These Underlying Portfolios may invest in equities, bonds
and fixed-income securities, money market instruments and cash. The Funds are
consequently exposed to market risk, interest rate risk, and manager risk.
11
<PAGE> 17
MARKET RISK. Market risk is the possibility that stock and bond prices
in general will fluctuate over time. The stock market tends to be cyclical. The
bond market is affected by interest rates; in general, bond prices fall when
interest rates rise and vice versa. The bond market is particularly subject to
interest rate risk.
INTEREST RATE RISK. Underlying Portfolios that invest in bonds, fixed
income instruments, and money market funds will be subject to the risk of
fluctuations in the interest rate.
MANAGER RISK. Manager risk refers to the possibility that the
investment adviser of an underlying mutual fund may fail to execute such fund's
investment strategy effectively, and thus fail to achieve its objective. As
discussed earlier, the Funds have concentrated their investments in the
Proprietary Portfolios, which are advised by Spears and KMFA. KMFA also serves
as the investment adviser to the Funds. Investors should be aware that the
Funds' performance directly correlates to the dollar-weighted investment
performance of the Underlying Portfolios in which they invest. As with any
mutual fund, a Fund's share value may decline. Changes in the net asset values
of the Underlying Portfolios affect a Fund's net asset value. Also, the Funds'
fulfillment of their investment objectives depends on the Underlying Portfolios
meeting their investment objectives. The Funds have little or no control over
the investment activities and management of the Other Portfolios. In addition,
as noted above, the Investment Adviser is subject to various conflicts of
interest because of the structure of the Funds.
There may develop additional expenses, ultimately borne by investors,
proceeding from the structure of the Funds. For example, the structure of these
Funds possibly may give rise to what are considered "wash" transactions, which
achieve no true investment purpose. These transactions might occur when the
investment adviser of one Underlying Portfolio purchases the same securities the
investment adviser of another is selling. In effect, these events would result
in an indirect expense of transaction charges and commissions to a Fund with no
corresponding investment benefit.
Through their investment in Underlying Portfolios, a Fund may
inadvertently invest 25% or more of its assets (i.e., concentrate) in one
industry, in addition to the mutual fund industry. Such indirect concentration
may subject shares of a Fund to greater fluctuation in value than would be the
case in the absence of such concentration.
OTHER INFORMATION
The investment objectives of the Funds are not fundamental policies,
which means they may be changed without a vote of the holders of a majority of a
Fund's outstanding shares (as defined in the Statement of Additional
Information). The investment policies of the Funds may be changed without an
affirmative vote of the holders of a majority of shares of the respective Funds
unless (1) a policy is expressly stated to be a fundamental policy of a Fund or
(2) a policy is expressly stated to be changeable only by such majority vote.
There can be no assurance that a Fund will achieve its investment objective.
12
<PAGE> 18
In addition, investments in a Fund are not insured against loss of
principal. No single Fund should be considered, by itself, to provide a complete
investment program for any investor.
In order to permit the sale of a Fund's shares in certain states, the
Company may, on behalf of a Fund, make commitments to a state or states that are
more restrictive than the investment policies and limitations described in the
Prospectus and in the Statement of Additional Information.
DESCRIPTIONS OF PROPRIETARY PORTFOLIOS
PERFORMANCE OF PROPRIETARY PORTFOLIOS
The following table summarizes the average annual total return (before
any sales load deductions) for each non-money market Proprietary Portfolio for
the period ending March 31, 1996:
TABLE I
<TABLE>
<CAPTION>
Proprietary Portfolio Inception One Year Five Year Ten Year
--------------------- --------- -------- --------- --------
<S> <C> <C> <C> <C>
KEY MUTUAL FUNDS(1):
SBSF Fund 12.80% 30.37% 13.29% 11.69%
SBSF Convertible Securities Fund 11.18% 20.43% 14.65% N/A
SBSF Capital Growth Fund 10.40% 30.03% N/A N/A
VICTORY PORTFOLIOS:
Value Fund 17.06% 30.25% N/A N/A
Diversified Stock Fund 14.11% 31.71% 14.50% N/A
Growth Fund 14.80% 28.30% N/A N/A
Special Value Fund 14.85% 22.45% N/A N/A
Special Growth Fund 14.20% 31.47% N/A N/A
Ohio Regional Stock Fund 12.99% 27.36% 16.92% N/A
International Growth Fund 6.79% 11.83% 8.32% N/A
Limited Term Income Fund 6.59% 7.40% 5.98% N/A
Investment Quality Bond Fund 4.59% 9.66% N/A N/A
Fund for Income 8.48% 9.91% 7.09% N/A
</TABLE>
The following table summarizes the average annual total return (taking
maximum sales load into account) for each non-money market Proprietary Portfolio
for the period ending March 31, 1996:
- --------------------
(1) All KMF figures are for periods ended 11/30/95. The KMF funds have no
sales load.
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<PAGE> 19
<TABLE>
<CAPTION>
TABLE II
Proprietary Portfolio Inception One Year Five Year
--------------------- --------- -------- ---------
<S> <C> <C> <C>
Value Fund 14.64% 24.02% N/A
Diversified Stock Fund 13.25% 25.44% 13.48%
Growth Fund 12.42% 22.15% N/A
Special Value Fund 12.47% 16.64% N/A
Special Growth Fund 11.72% 25.21% N/A
Ohio Regional Stock Fund 12.13% 21.28% 15.79%
International Growth Fund 5.90% 6.50% 7.26%
Limited Term Income Fund 6.26% 5.28% 5.55%
Investment Quality Bond Fund 2.41% 4.49% N/A
Fund for Income 8.24% 7.66% 6.66%
</TABLE>
DESCRIPTION OF UNDERLYING KEY MUTUAL FUNDS:
SBSF FUND. The Fund seeks to provide a high total return over the long term
consistent with reasonable risk. In seeking its objective, the SBSF Fund will
invest primarily in common stocks which in the opinion of the Adviser have the
potential for capital appreciation in excess of market averages during periods
of market strength while attempting to preserve capital during periods of market
weakness.
SBSF CONVERTIBLE SECURITIES FUND. The Fund seeks to provide a high level of
current income together with long-term capital appreciation. The SBSF
Convertible Securities Fund will invest primarily in convertible bonds,
corporate notes, convertible preferred stocks and other securities convertible
into common stock.
SBSF CAPITAL GROWTH FUND. The Fund seeks to provide capital appreciation. The
SBSF Capital Growth Fund seeks to achieve its objective by investing in equity
securities of companies which the Adviser believes are likely to have rapid
growth in earnings or cash flow. The SBSF Capital Growth Fund will invest
primarily in the securities of small to medium capitalization companies.
DESCRIPTION OF UNDERLYING VICTORY PORTFOLIOS:
VALUE FUND. The Fund seeks to provide long-term growth of capital and dividend
income. The Fund pursues this objective by investing primarily in a diversified
group of common stocks with an emphasis on companies with above average total
return potential.
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<PAGE> 20
DIVERSIFIED STOCK FUND. The Fund seeks to provide long-term growth of capital.
The Fund pursues this investment objective by investing primarily in common
stocks and securities convertible into common stocks issued by established
domestic and foreign companies.
GROWTH FUND. The Fund seeks to provide long-term growth of capital. The Fund
pursues this objective by investing primarily in common stocks of issuers listed
on a nationally recognized exchange with an emphasis on companies with superior
prospects for long-term earnings growth and price appreciation.
SPECIAL VALUE FUND. The Fund seeks to provide long-term growth of capital and
dividend income. The Fund pursues this objective by investing primarily in
common stocks of small and medium-sized companies listed on a nationally
recognized exchange with an emphasis on companies with above average total
return potential.
SPECIAL GROWTH FUND. The Fund seeks to provide capital appreciation. The Fund
pursues this investment objective by investing primarily in equity securities of
companies that have market capitalizations of $750 million or less at the time
of purchase.
OHIO REGIONAL STOCK FUND. The Fund seeks to provide capital appreciation. The
Fund pursues this objective by investing primarily in common stocks and
securities convertible into common stocks issued by companies whose headquarters
are located in the State of Ohio. The Fund's policy of concentrating its
investments in the State of Ohio means that its assets may be subject to greater
risk from economic, political or other developments having an unfavorable impact
upon the State of Ohio. Moreover, because of the geographic location, the Fund
may be less varied (by industry and by issuer) than other funds with similar
investment objectives and no such geographic limitation.
INTERNATIONAL GROWTH FUND. The Fund seeks to provide capital growth consistent
with reasonable investment risk. The Fund pursues this objective by investing
primarily in equity securities of foreign corporations, most of which will be
denominated in foreign currencies.
LIMITED TERM INCOME FUND. The Fund seeks to provide income consistent with
limited fluctuation of principal. The Fund pursues this objective by investing
in a portfolio of high grade, fixed income securities with a dollar-weighted
average maturity of one to five years, based on remaining maturities.
INVESTMENT QUALITY BOND FUND. The Fund seeks to provide a high level of income.
The Fund pursues this objective by investing primarily in investment-grade bonds
issued by corporations and the U.S. Government and its agencies or
instrumentalities.
FUND FOR INCOME. The Fund seeks to provide a high level of current income
consistent with preservation of shareholders' capital. The Fund pursues this
objective by investing primarily in selected mortgage-related securities.
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<PAGE> 21
FINANCIAL RESERVES FUND. The Fund seeks to obtain as high a level of current
income as is consistent with preserving capital and providing liquidity. The
Fund pursues this investment objective by investing primarily in a portfolio of
high-quality U.S. dollar denominated money market instruments. The Fund seeks to
maintain a constant net asset value of $1.00 per unit of beneficial interest,
and shares of the Fund are offered at net asset value.
ADDITIONAL INFORMATION REGARDING CERTAIN OF THE PROPRIETARY PORTFOLIOS'
INVESTMENTS
The following paragraphs provide a brief description of some of the
types of securities in which certain Proprietary Portfolios may invest in
accordance with their respective investment objectives, policies and
limitations. The following also includes a brief description of certain risk
factors associated with certain of the investment activities of the Proprietary
Portfolios. Additional relevant information is provided in the Statement of
Additional Information. The prospectuses and statements of additional
information of the Proprietary Portfolios also detail permissible investment
activities and associated risk factors for each Proprietary Portfolio.
- SHORT-TERM OBLIGATIONS. Each of the Proprietary Portfolios may hold
short-term obligations generally limited to "investment grade" liquid debt
securities such as commercial paper, certificates of deposit, bankers'
acceptances, repurchase agreements with maturities of less than seven days and
United States Treasury Bills. Bankers' acceptances are instruments of domestic
banks which are drafts or bills of exchange "accepted" by a bank or trust
company as an obligation to pay on maturity. For a discussion of repurchase
agreements, see below. "Investment grade" obligations are those rated at the
time of purchase within the four highest rating categories assigned by a
nationally recognized statistical ratings organization ("NRSRO") or, if unrated,
obligations that the Proprietary Portfolio Adviser or Sub-Adviser determine to
be of comparable quality. The applicable securities ratings are described in the
Appendix to the Statement of Additional Information.
- FUTURES CONTRACTS. Certain Proprietary Portfolios may also enter into
contracts for the future delivery of securities or foreign currencies and
futures contracts based on a specific security, class of securities, foreign
currency or an index, purchase or sell options on any such futures contracts and
engage in related closing transactions. A futures contract on a securities index
is an agreement obligating either party to pay, and entitling the other party to
receive, while the contract is outstanding, cash payments based on the level of
a specified securities index.
Futures transactions may require the Proprietary Portfolios to
segregate assets to cover contracts that require it to purchase securities or
currencies. The Proprietary Portfolios may lose the expected benefit of futures
transactions if interest rates, exchange rates or securities prices move in an
unanticipated manner. Such unanticipated changes may also result in poorer
overall performance than if the Proprietary Portfolios had not entered into any
futures transactions. In addition, the value of the Proprietary Portfolio's
futures positions may not prove to be perfectly or even highly correlated with
the value of its portfolio securities or foreign currencies, limiting the
Proprietary Portfolio's ability to hedge effectively against interest rate,
exchange rate and/or
16
<PAGE> 22
market risk and giving rise to additional risks. There is no assurance of
liquidity in the secondary market for purposes of closing out futures positions.
- SECURITIES LENDING. In order to generate additional income, certain
of the Proprietary Portfolios may, from time to time, lend their portfolio
securities. The Proprietary Portfolio must receive collateral equal to 100% of
the securities' value in the form of cash or U.S. Government securities, plus
any interest due which collateral must be marked to market daily by the
Proprietary Portfolio's Adviser or Sub-Adviser. Should the market value of the
loaned securities increase, the borrower must furnish additional collateral to
the Proprietary Portfolios. During the time portfolio securities are on loan,
the borrower pays the Proprietary Portfolios amounts equal to any dividends or
interest paid on such securities plus any interest negotiated between the
parties to the lending agreement. Loans are subject to termination by the
Proprietary Portfolio or the borrower at any time. While the Proprietary
Portfolios do not have the right to vote securities on loan, the Proprietary
Portfolios intend to terminate any loan and regain the right to vote if that is
considered important with respect to the Proprietary Portfolio's investment.
Each Proprietary Portfolio that has the authority to lend portfolio securities
will limit its securities lending to one-third of its total net assets.
- OPTIONS. Certain of the Proprietary Portfolios may engage in writing
call options from time to time as a hedging device. The Proprietary Portfolio
will write only covered call options, i.e., so long as the Proprietary Portfolio
is obligated as the writer of a call option, the Proprietary Portfolio will
either own the underlying securities subject to the call, or hold a call at the
same exercise price, for the same exercise period, and on the same securities as
the call written. Such options must be listed on a national securities exchange
and issued by the Options Clearing Corporation.
Certain of the Proprietary Portfolios may write covered call options
and "covered" put options. A "covered" put option means generally that so long
as the Proprietary Portfolio is obligated as the writer of the put option, the
Proprietary Portfolio will maintain liquid assets with a value equal to the
exercise price in a segregated account with its custodian, or hold a put on the
same underlying security at an equal or greater exercise price. Options in which
certain Proprietary Portfolios invest may be traded on exchanges and in the
over-the-counter market.
Options can be volatile investments and involve certain risks, such as
the inability to close out the option because of an illiquid secondary market,
losses incurred due to poor correlation with other investments, or losses due to
application of a hedge at an inappropriate time or poor judgment of market
conditions by the Adviser. Accordingly, certain Proprietary Portfolios intend to
limit investments in options to 25% of their total assets.
- CONVERTIBLE SECURITIES. Certain of the Proprietary Portfolios will
purchase convertible securities (typically a bond or preferred stock that may be
converted at a stated price within a specified period of time into a specified
number of shares of common stock of the same or a different issuer) which may or
may not be rated by an NRSRO.
17
<PAGE> 23
As a fixed-income security, a convertible security tends to increase in
market value when interest rates decline and decrease in value when interest
rates rise. However, because the price of a convertible security also is
influenced by the market value of the security's underlying common stock, the
price of a convertible security tends to increase as the market value of the
underlying stock increases, and decrease as the market value of the underlying
stock declines. While no securities investment is without some risk, investments
in convertible securities generally entail less risk than investments in the
common stock of the same issuer.
- ILLIQUID SECURITIES. Certain of the Proprietary Portfolios may invest
a portion of their net assets in illiquid securities, including securities
restricted as to disposition under the federal securities laws, securities as to
which there are no readily available market quotations and repurchase agreements
with a maturity in excess of 7 days. However, illiquid securities for purposes
of this limitation do not include securities eligible for resale to qualified
institutional buyers pursuant to Rule 144A under the Securities Act of 1933, as
amended (the "1933 Act"), which the Company's Board of Directors or the Fund's
Adviser has determined are liquid. Such a determination would take into
consideration, among other factors, valuation, liquidity and availability of
information. An insufficient number of qualified institutional buyers interested
in purchasing Rule 144A securities held by the Funds could adversely affect the
liquidity of such securities. The Funds might be unable to dispose of such
securities promptly or at reasonable prices.
MANAGEMENT OF THE FUNDS
DIRECTORS AND OFFICERS
The Directors, in addition to reviewing the actions of the Funds'
Adviser, Administrator and Distributor, as set forth below, decide upon matters
of general policy. The Company's officers conduct and supervise the daily
business operations of the Funds. The names, addresses and business affiliations
of the Directors and officers of the Company are set forth in the Statement of
Additional Information.
THE INVESTMENT ADVISER
The investment adviser to the Funds is KeyCorp Mutual Fund Advisers,
Inc. ("KMFA"), an Ohio corporation that is registered as an investment adviser
with the Securities and Exchange Commission. The Adviser is a wholly owned
subsidiary of KeyCorp Asset Management Holdings, Inc. and is an indirect wholly
owned subsidiary of KeyBank National Association, a wholly-owned subsidiary of
KeyCorp, one of the largest financial services holding companies in the United
States. KeyCorp's principal offices are located at 127 Public Square, Cleveland,
Ohio 44114.
The Adviser and its affiliates, as of March 31, 1996, managed
approximately $66 billion in assets for numerous clients including large
corporate and public retirement plans, Taft-Hartley plans, foundations and
endowments, high net worth individuals and mutual funds. The Adviser's
18
<PAGE> 24
principal offices are located at 127 Public Square, Cleveland, Ohio 44114. KMFA
is newly formed, but many of its professionals have managed mutual funds in
their capacity as employees of other subsidiaries of KeyCorp. KMFA was organized
as an Ohio corporation on July 27, 1995, and is registered as an investment
adviser under the Investment Advisers Act of 1940, as amended.
Pursuant to an Investment Advisory Agreement and subject to the general
supervision of the Board, the Adviser furnishes a continuous investment program
for the Funds, conducts investment research, makes the day-to-day investment
decisions for the Funds, executes purchase and sale orders for the portfolio
transactions of the Funds and generally manages and supervises the Funds'
investments in accordance with the stated policies of the Funds.
The Investment Advisory Agreement also provides that KMFA may delegate
a portion of its responsibilities to a sub-adviser. In addition, the Investment
Advisory Agreement provides that KMFA may render services through its own
employees or through the employees of one or more affiliated companies that are
qualified to act as investment adviser to the Funds and are under the common
control of KeyCorp as long as all such persons are functioning as part of an
organized group of persons that is managed by authorized officers of KMFA.
As compensation for the services rendered and related expenses borne by
the Adviser under the Investment Advisory Agreement, each Fund will pay the
Adviser a fee, computed daily and payable monthly, equal to .15 % per annum of
the Fund's average daily net assets. The Adviser is obligated to reimburse the
Funds in the event the Funds' expenses exceed certain prescribed limits. See
"Expenses, Distribution Plan and Shareholder Servicing Plan."
The persons primarily responsible for the investment management of the
Funds as well as their previous experience is as follows:
<TABLE>
<CAPTION>
FUND NAME PORTFOLIO MANAGER MANAGING FUND SINCE PREVIOUS EXPERIENCE
<S> <C> <C> <C>
Growth [NAME/TITLE] Commencement of [FOR LAST 5 YEARS]
Operations
Moderate Growth Commencement of
Operations
Conservative Growth Commencement of
Operations
</TABLE>
THE ADMINISTRATOR, DISTRIBUTOR
AND FUND ACCOUNTANT
BISYS Fund Services (the "Administrator") serves as the administrator
for the Funds. The Administrator generally assists in all aspects of the Funds'
administration and operation.
19
<PAGE> 25
Pursuant to the Administration Agreement between the Administrator and the
Company, for expenses incurred and services provided as Administrator, BISYS
Fund Services receives a fee from each Fund, computed daily and paid monthly, at
an annual rate of 1.00% of a Fund's average daily net assets. The Administrator
may periodically waive all or a portion of its administration fee with respect
to a Fund.
BISYS Fund Services also serves as the independent underwriter and
distributor of the shares of the Funds (the "Distributor"). Pursuant to the
Distribution Agreement between the Company and the Distributor, BISYS Fund
Services is obligated to use its best efforts to sell shares of the Funds. In
addition, under the Distribution Agreement, BISYS Fund Services may enter into
agreements with selected dealers for the distribution of shares.
The Distributor, at its expense, may provide additional cash
compensation to dealers in connection with sales of shares of the Funds. The
maximum cash compensation payable by the Distributor is [4.00%] of the net
asset value of the shares of a Fund. KMFA neither participates in nor is
responsible for the underwriting of Fund shares. In addition, the Distributor
will, from time to time and at its own expense, provide compensation, including
financial assistance, to dealers in connection with conferences, sales or
training programs for their employees, seminars for the public, advertising
campaigns regarding one or more Key Mutual Funds and/or other dealer-sponsored
special events, including payment for travel expenses and lodging incurred in
connection with trips taken by invited registered representatives and members
of their families to locations within or outside of the United States for
meetings or seminars of a business nature. Compensation will include the
following types of non-cash compensation offered through sales contests: (1)
vacation trips, including the provision of travel arrangements and lodging; (2)
tickets for entertainment events (such as concerts, cruises and sporting
events) and (3) merchandise (such as clothing, trophies, clocks and pens).
Dealers may not use sales of the Funds' shares to qualify for this compensation
if prohibited by the laws of any state or any self-regulatory organization,
such as the National Association of Securities Dealers, Inc. None of the
aforementioned compensation is paid for by the Funds or their shareholders.
BISYS Fund Services, Inc. ("BISYS, Inc." or the "Fund Accountant")
provides the Funds with certain accounting services pursuant to a Fund
Accounting Agreement with the Company. For its services as Fund Accountant, each
Fund pays a fee to BISYS, Inc.
Morrison & Foerster LLP, counsel to the Company, has advised the
Company that KMFA may perform the services contemplated by the Investment
Advisory Agreement without violation of the Glass-Steagall Act or other
applicable laws or regulations. Such counsel has pointed out, however, that
there are no controlling judicial or administrative interpretations or decisions
and that future judicial or administrative interpretations of, or decisions
relating to, present federal or state statutes, including the Glass-Steagall
Act, and regulations relating to the permissible activities of banks and their
subsidiaries or affiliates, as well as future changes in such statutes,
regulations and judicial and administrative decisions or interpretations, could
prevent KMFA from continuing to perform, in whole or in part, such services. If
KMFA were prohibited from performing any of such services, it is expected that
the Board of Directors of the Company would recommend to each Fund's
shareholders that they approve a new investment advisory agreement with another
entity or entities qualified to perform such services.
EXPENSES, DISTRIBUTION PLAN AND SHAREHOLDER SERVICING PLAN
Except as set forth above under "Management of the Funds" and as set
forth below, each of the Funds bears the expenses directly applicable to it and
a portion of the general administrative expenses, applicable to all the Funds,
which may be allocated among the Funds in a manner believed to be fair and
equitable. Expenses that are directly applicable to a Fund include expenses of
portfolio transactions, shareholder servicing costs, expenses of registering the
shares under federal and state securities laws, pricing costs (including the
daily calculation of net asset value), accounting costs, interest, certain
taxes, legal and auditing expenses directly incurred by the Fund, and charges of
KMFA, BISYS Fund Services, the Custodian, the Fund Accountant, the Shareholder
Servicing Agent and the Transfer Agent. General expenses which would be
allocated
20
<PAGE> 26
include directors' fees, general corporate legal and auditing expenses, state
franchise taxes, costs of printing proxies, shareholder reports and prospectuses
sent to existing shareholders, trade association fees, and Securities and
Exchange Commission fees.
The Adviser has agreed that if in any fiscal year the sum of each
Fund's expenses exceeds the limits set by applicable regulations of state
securities commissions, the amounts payable by the Funds to KMFA for the
advisory fee for that year shall each be proportionately reduced. For further
information see "Expenses and Distribution Plan" in the Statement of Additional
Information.
The expenses associated with investing in a "fund of funds," such as
the Growth Fund, Moderate Growth Fund, and Conservative Growth Fund, are
generally higher than those of investment companies that do not invest in other
mutual funds. These increased expenses stem from the fact that investors must
indirectly pay a portion of the operating costs of the Underlying Portfolios.
The structure of the Funds will avoid layering of costs to a meaningful extent
based on the fact that (a) any advisory fees charged are based on services that
are in addition to, and not duplicative of, services provided under any
Proprietary Portfolio's advisory contract; (b) the Funds pay no front-end or
contingent deferred sales charges in connection with the purchase or redemption
of shares of the Proprietary Portfolios; (c) any asset-based sales charges or
service fees associated with the purchase or redemption of the shares of the
Funds do not exceed the limits set forth in the NASD's Rules of Fair Practice,
Art. III, Sect. 26, when aggregated with any asset-based sales charges or
service fees that the Funds may pay relating to acquisition, holding or
disposition of Proprietary Portfolio shares; (d) administrative and other fees
charged by both the Funds and the Proprietary Portfolios are not redundant
inasmuch as distinct services are being provided at each level; and (e) any
additional incremental cost incurred by investing in the Funds is in return for
a substantial investment management service, namely the initial and ongoing
asset allocation of investments made in the Proprietary Portfolios, and
provision of meaningful additional diversification benefits.
The Company has adopted a Shareholder Servicing Plan for the Growth,
Moderate Growth, and Conservative Growth Funds. In accordance with the
Shareholder Servicing Plan, the Company, on behalf of the Funds, may enter into
shareholder service agreements under which the Funds may pay fees of up to 0.25%
of its average daily net assets for fees incurred in connection with the
personal service and the maintenance of accounts holding the shares of the
Funds. Such agreements are entered between the Company, on behalf of the Funds,
and various shareholder servicing agents, including the Distributor, Key Trust
Company of Ohio, N.A. and its affiliates, and other financial institutions and
securities brokers (each a "Shareholder Servicing Agent"). Each Shareholder
Servicing Agent generally will provide support services to shareholders by
establishing and maintaining accounts and records, processing dividend and
distribution payments, providing account information, arranging for bank wires,
responding to routine inquiries, forwarding shareholder communications,
assisting in the processing of purchase, exchange and redemption requests, and
assisting shareholders in changing dividend options, account designations and
addresses. Shareholder Servicing Agents may periodically waive all or a portion
of their respective shareholder servicing fees with respect to the Funds.
21
<PAGE> 27
The Company has also adopted a Distribution Plan (the "Distribution
Plan") for the Growth, Moderate Growth, and Conservative Growth Funds pursuant
to Rule 12b-1 under the 1940 Act. No separate payments are authorized to be made
by the Funds under the Plan. Rather, the Plan provides that to the extent that
any portion of the fees payable under the Shareholder Servicing Plan or any
Shareholder Servicing Agreement (described above) is deemed to be for services
primarily intended to result in the sale of Fund shares, such fees are deemed
approved and may be paid pursuant to the Plan and in accordance with Rule 12b-1.
Each Fund is actively managed and has no restrictions upon portfolio
turnover. The annual turnover rate of each Fund is not expected to exceed
[----%].
DETERMINATION OF NET ASSET VALUE
The net asset values (NAV) of the shares of the Growth Fund, Moderate
Growth Fund, and Conservative Growth Fund are determined and its shares are
priced as of the close of regular trading of the New York Stock Exchange
("NYSE"), which is generally at 4:00 P.M., Eastern Standard Time, each Business
Day (the "Valuation Time"). A "Business Day" is a day on which the NYSE is open
for trading. The NYSE is closed in observance of the following holidays: New
Year's Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor
Day, Thanksgiving and Christmas.
In general, a Fund's net asset value per share is determined by
dividing the total value of all underlying fund investments and securities held
(both valued at current market value or by other method approved by the
respective Board of the Proprietary Portfolios) and other assets, less
liabilities, by the total number of shares then outstanding.
PURCHASING SHARES
Shares may be purchased directly or through an Investment Professional
of a securities broker or other financial institution that has entered into
selling or servicing agreements with Key Mutual Funds or BISYS Fund Services. An
Investment Professional is a salesperson, financial planner, investment adviser
or trust officer who provides you with information regarding the investment of
your assets. Shares are also available to clients of bank trust departments who
have qualified trust accounts. The minimum investment is $500 ($250 for
Individual Retirement Accounts) for the initial purchase and $25 thereafter.
Accounts set up through a bank trust department or an Investment Professional
may be subject to different minimums, features, requirements and fees. The
Investment Professional will provide this information to you.
Shares of the Funds are sold at the net asset value per share (see
"Determination of Net Asset Value") next determined after receipt and acceptance
by State Street Bank and Trust Company, Two Heritage Drive, Quincy, MA 02171,
the Funds' transfer agent (the "Transfer Agent"), of an order to purchase
shares. There are no sales commissions.
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Purchases of shares will be effected only on a Business Day (as defined
in "Determination of Net Asset Value") of Key Mutual Funds. An order received
prior to the Valuation Time on any Business Day will be executed at the net
asset value determined as of the next Valuation Time on that Business Day. An
order received after the Valuation Time on any Business Day will be executed at
the net asset value determined as of the next Valuation Time on the next
Business Day of Key Mutual Funds. Generally, shares of the Funds begin accruing
income dividends on the day they are purchased.
INVESTING DIRECTLY
BY MAIL:
You may purchase shares by completing and signing an account
application (initial purchase only) and mailing it, together with a check (or
other negotiable bank draft or money order) in at least the minimum investment
requirement to:
Key Mutual Funds
P.O. Box 8527
Boston, Massachusetts 02266-8527
Subsequent purchases may be made in the same manner.
BY TELEPHONE:
Subsequent purchases of shares of the Funds may be made by telephone if
you have checked the Telephone Authorization box and supplied the necessary bank
information on the Account Application. The purchase amount will be transferred
between the bank account designated and your fund account via Automated Clearing
House ("ACH"). Only a bank account maintained in a domestic financial
institution which is an ACH member may be so designated. The Funds may modify or
terminate the telephone and/or ACH privilege at any time or charge a service fee
upon notice to shareholders. No such fee is currently contemplated. If assets
are not available at the time your order is processed, the Funds may cancel the
order and redeem shares held in the shareholder's account to compensate the
Funds for any decline in the value of the purchased shares. Note that this
service requires approximately fifteen days to establish. Therefore, do not make
your initial purchase using this method.
BY WIRE:
If an account application has been previously received by the Transfer
Agent, you may also purchase shares by wiring funds to: State Street Bank and
Trust Co., ABA #01100028, For Credit to DDA Account #9905-201-1. For Further
Credit to Account Number (insert your account number, name and control number
assigned by the Transfer Agent). The Transfer Agent does not charge a wire fee.
PRIOR TO WIRING ANY FUNDS AND IN ORDER TO ENSURE THAT WIRE ORDERS ARE INVESTED
PROMPTLY, YOU MUST CALL THE TRANSFER AGENT AT 800-539-3863.
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INVESTING THROUGH INVESTMENT PROFESSIONALS OR A BANK TRUST DEPARTMENT
Shares may be purchased by investors who designate an Investment
Professional or a bank trust department through procedures established by the
Transfer Agent in connection with requirements of qualified accounts maintained
by or on behalf of certain persons by Investment Professionals and bank trust
departments. An Investment Professional is a salesperson, financial planner,
investment adviser or trust officer who provides you with information regarding
the investment of your assets. With respect to such purchases, it is the
responsibility of the Investment Professional or a bank trust department to
transmit purchase orders to the Transfer Agent and to deliver federal funds for
purchase on a timely basis in order to obtain the price then in effect. Accounts
set up through an Investment Professional or bank trust department may be
subject to different minimums, features, requirements and fees in connection
with purchases and redemptions of shares. Contact your Investment Professional
or trust representative for complete information.
The services rendered by your bank trust department, including
affiliates of KMFA, in the management of its accounts are not duplicative of any
of the services for which KMFA is compensated. The additional fees paid by
clients of bank trust departments, their affiliates, or an Investment
Professional should be considered in calculating the net yield on an investment
in a Fund, although such charges do not affect the Fund's dividends or
distributions.
ADDITIONAL INVESTMENT REQUIREMENTS
All purchases must be made in U.S. dollars. Checks must be drawn on
U.S. banks. No cash will be accepted. All purchases made by check should be in
U.S. dollars and made payable to Key Mutual Funds, or, in the case of a
retirement account, to the custodian or trustee. Third party checks will not be
accepted. When purchases are made by check or periodic account investment,
redemptions will not be allowed until the investment being redeemed has been in
the account for 15 calendar days. If you make a purchase with more than one
check, each check must have a value of at least $25, and the minimum investment
requirement still applies. Key Mutual Funds and its servicing agents reserve the
right to limit the number of checks processed at one time. If your check does
not clear, your purchase may be canceled and you could be liable for any losses
and/or fees incurred. Payment for purchase is expected at the time of the order.
If payment is not received within three business days of the order, the order
may be canceled, and you could be held liable for resulting fees and/or losses.
You may initiate most transactions by telephone through your Investment
Professional or bank trust department. Subsequent investments by telephone may
be made directly. Note that Key Mutual Funds and its agents will not be
responsible for any losses resulting from unauthorized transactions if they
follow reasonable procedures designed to verify the identity of the caller.
These procedures may include requesting additional information or using
personalized security codes. Your Investment Professional or the Transfer Agent
may also record calls, and you should verify the accuracy of your confirmation
statements immediately after you receive
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them. The Transfer Agent may reject any purchase order for the Funds' shares
within its sole discretion.
You will receive a monthly statement reflecting all transactions that
affect the share balance or the registration of your Fund account. You will
receive a confirmation after every transaction that affects the share balance of
your Fund account, except for dividend reinvestment, systematic investment and
systematic withdrawal transactions. These transactions will be detailed in your
Fund account statement. The Funds do not issue stock certificates for the
shares.
Although the Funds continuously offer their shares for sale, each Fund
reserves the right to reject any purchase request.
THE SYSTEMATIC INVESTMENT PLAN
Under the Systematic Investment Plan, you may make regular systematic
monthly purchases of shares of a Fund through automatic deductions from your
bank account(s). Upon obtaining your authorization, Key Mutual Funds' Transfer
Agent will deduct the specified amount from your designated bank account, which
will then be automatically invested in shares of the relevant Fund at the net
asset value next determined. Bank accounts will be debited on any day from the
1st through the 28th of each month, as selected by the shareholder. You must
first meet a Fund's initial investment requirement of $500 and will be subject
to a minimum subsequent investment of $25. For officers, trustees, directors and
employees, including retired directors and employees, of KMFA, Spears, Key
Mutual Funds, KeyCorp, BISYS Fund Services and its affiliates, (and family
members of each of the foregoing) who participate in the Systematic Investment
Plan, there is no minimum initial investment required.
To participate in the Systematic Investment Plan, complete the
appropriate section of the account application and attach a voided personal
check with the bank's magnetic ink coding number across the front. If the bank
account is jointly owned, all owners must sign the application. Account
applications can be obtained by calling the Transfer Agent at 800-539-3863. To
change or discontinue existing Systematic Investment Plan instructions, submit a
written request to or call the Transfer Agent at 800-539-3863.
THE SYSTEMATIC WITHDRAWAL PLAN
The Systematic Withdrawal Plan enables shareholders to make regular
monthly, quarterly, semi-annual or annual redemptions of shares. With your
authorization, the Transfer Agent will automatically redeem shares at the net
asset value on the date of the withdrawal and have the proceeds transferred
according to your written instructions. Fund accounts will be debited on any day
from the 1st through the 28th of each month.
You may have checks sent from your Fund account directly to you, to
your bank checking account or to a third person. If you opt to have the proceeds
sent to your bank checking account, a voided personal check with the bank's
magnetic coding number across the front must be
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attached to the account application. If the bank checking account is jointly
owned, all owners must sign the application.
To participate in the Systematic Withdrawal Plan, the required minimum
balance is $5,000 per Fund. The required minimum withdrawal is $25.
To participate in the Systematic Withdrawal Plan, call 800-539-3863 for
more information. Systematic Withdrawal Plan payments are drawn from share
redemptions. If Systematic Withdrawal Plan redemptions exceed income and capital
gain dividend distributions earned on Fund shares, the Fund account may
eventually be exhausted. Purchases of additional shares concurrent with
withdrawals may be disadvantageous to certain shareholders because of tax
liabilities. The Systematic Withdrawal Plan is not necessarily appropriate for
use in conjunction with the Systematic Investment Plan. To change or terminate
Systematic Withdrawal Plan instructions, submit a written request to, or call
the Transfer Agent at 800-539-3863. Your account cannot be closed automatically
by depleting the assets in your Systematic Withdrawal Plan. The Systematic
Withdrawal Plan may be modified or terminated at any time without notice.
If the amount of the automatic withdrawal exceeds the income accrued
for the period, the principal balance invested will be reduced and shares will
be redeemed.
REDEEMING SHARES
Shares may ordinarily be redeemed by mail or telephone. However, all or
part of your shares may be redeemed in accordance with instructions and
limitations pertaining to your account with an Investment Professional. For
example, if you have agreed with an Investment Professional to maintain a
minimum balance in your account with the Investment Professional, and the
balance in that account falls below that minimum, you may be obligated to
redeem, or the Investment Professional may redeem for you and on your behalf,
all or part of your shares to the extent necessary to maintain the required
minimum balance.
BY MAIL:
In order to redeem shares by mail, send a written request to the
Transfer Agent at: Key Mutual Funds, P.O. Box 8527, Boston, MA 02266-8527. The
Transfer Agent may require a signature guarantee by an eligible guarantor
institution. A signature guarantee is designed to protect you, the Fund, and
your and the Fund's agents from fraud. A written redemption request requires a
signature guarantee for redemptions of more than $10,000 worth of shares; if
your Fund account registration has changed within the last 60 days; if the check
is not being mailed to the address on your account; if the check is not being
made out to the account owner; or if the redemption proceeds are being
transferred to another account within Key Mutual Funds or the Victory Portfolios
with a different registration. The following institutions should be able to
provide you with a signature guarantee: banks, brokers, dealers, credit unions
(if authorized under state law), securities exchanges and associations, clearing
agencies, and savings associations. A signature guarantee may not be provided by
a notary public. The Transfer Agent reserves the right to reject any signature
guarantee if (1) it has reason to believe that the signature is not
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genuine, (2) it has reason to believe that the transaction would otherwise be
improper, or (3) the guarantor institution is a broker or dealer that is neither
a member of a clearing corporation nor maintains net capital of at least
$100,000.
BY TELEPHONE:
The payment of redemption proceeds may be made by telephone if you have
checked the Telephone Authorization box and supplied the necessary bank
information on the Fund's Account Application. Proceeds may be wired to a
domestic financial institution, sent via ACH, mailed to the address of record,
or mailed to a previously designated alternate address. If you select the ACH
method, only a bank account maintained in a domestic financial institution which
is an ACH member may be so designated.
It is not necessary to confirm telephone redemption requests in
writing. If you did not originally select the telephone authorization privilege,
you must provide written instructions as well as a signature guarantee to the
Transfer Agent to add this feature. Neither Key Mutual Funds nor its service
agents will be liable for any loss, damages, expense or cost arising out of any
telephone redemption effected in accordance with Key Mutual Funds' telephone
redemption procedures and pursuant to instructions reasonably believed to be
genuine. Key Mutual Funds will employ procedures designed to provide reasonable
assurance that instructions by telephone are genuine; if these procedures are
not followed, Key Mutual Funds or its service agents may be liable for any
losses due to unauthorized or fraudulent instructions. These procedures include,
but are not limited to, recording of phone conversations, sending confirmations
to shareholders within 72 hours of the telephone transaction, verification of
account name and account number or tax identification number, and sending
redemption proceeds to the address of record, a previously designated bank
account or alternate address. For telephone redemptions, call the Transfer Agent
at 800-539-3863. If you are unable to reach the Transfer Agent by telephone (for
example, during time of unusual market activity), consider placing your order by
mail directly to the Transfer Agent.
ADDITIONAL REDEMPTION INFORMATION
Redemption orders are effected at the net asset value per share next
determined after the shares are properly tendered for redemption, as described
above. The proceeds paid upon redemption of shares in a Fund may be more or less
than the amount invested. A redemption, including those under the Systematic
Withdrawal Plan, may therefore provide gain or loss for federal income tax
purposes. Payment to shareholders for shares redeemed will be made within three
business days after receipt by the Transfer Agent of the request for redemption.
At various times, Key Mutual Funds may be requested to redeem shares of
a Fund for which good payment has not yet been received. In such circumstances,
Key Mutual Funds may delay the forwarding of proceeds for 15 days or more
without interest to the shareholder until payment has been collected for the
purchase of such shares. Key Mutual Funds intend to pay cash for all shares
redeemed, but under unusual circumstances, Key Mutual Funds may make payment
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<PAGE> 33
wholly or partly in portfolio securities at their then-current market value
equal to the redemption price. In such cases, an investor may incur brokerage
costs in converting such securities to cash.
Due to the relatively high cost of handling small investments, Key
Mutual Funds reserves the right to redeem, at net asset value, shares in your
account if, because of redemptions of shares by you or on your behalf, your
account with respect to a Fund has a value of less than $500 (except with
respect to officers, trustees, directors and employees, including retired
directors and employees, of KMFA, Spears, Key Mutual Funds, KeyCorp, BISYS and
its affiliates, and the Administrator and its affiliates (and family members of
each of the foregoing), participating in the Systematic Investment Plan, to whom
no minimum balance requirement applies). Before Key Mutual Funds exercises the
right to redeem such shares and to send the proceeds to you, you will be given
notice that the value of the shares in your account is less than the minimum
amount and will be allowed 60 days to make an additional investment in the Fund
in an amount which will increase the value of the account to at least $500, if
applicable.
Key Mutual Funds reserves the right to reject any order for the
purchase of its shares in whole or in part. In addition, the Funds have reserved
the right to redeem involuntarily the shares of any shareholder if the net asset
value of all remaining shares in the shareholder's account after a redemption is
less than $500. IRA and Keogh accounts are exempt from this mandatory
redemption. Written notice of a proposed mandatory redemption will be given at
least 60 days in advance to any shareholder whose account is to be redeemed.
During the notice period a shareholder may avoid mandatory redemption by
purchasing sufficient shares to increase his or her total net asset value to at
least $500.
The Funds may suspend the right of redemption during any period when
(a) trading on the New York Stock Exchange is restricted as determined by the
Securities and Exchange Commission or such Exchange is closed, other than
customary weekend and holiday closings; (b) the Commission has by order
permitted such suspension or postponement; or (c) an emergency, as defined by
rules of the Commission, exists making disposal of portfolio securities or
determination of the value of assets of the Funds not reasonably practicable. In
case of a suspension of the right of redemption, the offer of redemption may be
withdrawn by the shareholder or payment will be sent to the shareholder at the
net asset value next determined after the suspension has been terminated.
EXCHANGE PRIVILEGES
Shares of the Fund may be exchanged for shares of certain funds of Key
Mutual Funds or the Victory Group at net asset value per share at the time of
exchange, without a sales charge. To exchange shares, you must meet several
conditions:
(1) Shares of the fund selected for exchange must be available for sale in
your state of residence.
(2) The prospectuses of this Fund and the fund whose shares you want to buy
must offer the exchange privilege.
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(3) You must hold the shares you buy when you establish your account for at
least 7 days before you can exchange them; after the account is open 7
days, you can exchange shares on any Business Day.
(4) You must meet the minimum purchase requirements for the fund you
purchase by exchange.
(5) The registration and tax identification numbers of the two accounts
must be identical.
(6) Before exchanging, obtain and read the prospectus for the fund you wish
to purchase by exchange.
Shares of a particular class may be exchanged only for shares of the
same class in the other fund of the Victory Group. For example, you can exchange
Class A shares of this Fund only for Class A shares of another fund. At present,
not all of the funds offer the same two classes of shares. If a fund has only
one class of shares that does not have a class designation, they are "Class A"
shares for exchange purposes. In some cases, sales charges may be imposed on
exchange transactions. Certain funds offer Class A or Class B shares and a list
can be obtained by calling the Transfer Agent at 800-539-3863. Please refer to
the Statement of Additional Information for more details about this policy.
Telephone exchange requests may be made by calling your Investment
Professional or the Transfer Agent at 800-539-3863 prior to Valuation Time on
any Business Day. (See "Determination of Net Asset Value.")
You can obtain a list of eligible funds of the Key Mutual Funds or
Victory Group by calling the Transfer Agent at 800-539-3863. Exchanges of shares
involve a redemption of the shares exchanged and a purchase of shares acquired.
There are certain exchange policies you should be aware of:
- Shares are normally redeemed from one fund and issued from the
other fund in the exchange transaction on the same Business Day on
which the Transfer Agent receives an exchange request by Valuation
Time (normally 4:00 p.m. Eastern time) that is in proper form, but
either fund may delay the issuance of shares of the fund into
which you are exchanging if it determines it would be
disadvantaged by a same-day transfer of the proceeds to buy
shares. For example, the receipt of multiple exchange requests
from a dealer in a "market-timing" strategy might create excessive
turnover in the Fund's portfolio and associated expenses
disadvantageous to the Fund.
- Because excessive trading can hurt fund performance and harm
shareholders, the Funds reserve the right to refuse any exchange
request that will impede a Fund' ability to invest effectively or
otherwise have the potential to disadvantage a Fund, or to refuse
multiple exchange requests submitted by a shareholder or dealer.
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<PAGE> 35
- Key Mutual Funds may amend, suspend or terminate the exchange
privilege at any time upon 60 days' written notice to
shareholders.
- If the Transfer Agent cannot exchange all the shares you request
because of a restriction cited above, only the shares eligible
will be exchanged.
- Each exchange may produce a gain or loss for tax purposes.
You may exchange shares of a Fund for shares of any other Fund of Key
Mutual Funds as well as for "Key" class shares of Funds of The Victory
Portfolios, so long as you maintain the requisite minimum account balance
applicable to each Fund owned immediately after the exchange. The exchange will
be made on the basis of the relative net asset values of the shares exchanged.
An exchange is considered to be a sale of shares for federal income tax purposes
on which you may recognize a capital gain or loss. Before an exchange can be
effected, you must receive a current prospectus of the Fund of Key Mutual Funds
or The Victory Portfolios for which the shares are exchanged. To request a
prospectus for any Fund of Key Mutual Funds or of The Victory Portfolios, call
the Transfer Agent at 800-539-3863. Key Mutual Funds reserves the right to
restrict, limit or terminate the terms of this exchange privilege upon sixty
days written notice to shareholders.
See "Redeeming Shares -- By Telephone" for a discussion of certain
limitations on the liability of the Funds and the Transfer Agent in connection
with unauthorized telephone transactions.
INVESTING FOR RETIREMENT
You may wish to invest in Key Mutual Funds in connection with
Individual Retirement Accounts (IRAs) and other retirement plans such as Simple
Employee Pension Plans (SEP/IRA), Salary Reduction Simplified Employee Pensions
Plans (SAR-SEP/IRA), 401(k) Plans, and 403(b) Plans. For more information about
investing in Key Mutual Funds through tax-deferred accounts, call 800-539-3863.
DIVIDENDS, DISTRIBUTIONS AND
FEDERAL INCOME TAXES
Each Fund declares and pays dividends from net investment income, each
calendar quarter. Each Fund's realized capital gains, if any, are distributed to
shareholders annually. Unless a Fund's shareholder instructs otherwise, such
dividends and capital gain distributions will be reinvested in additional
shares, at net asset value as of the close of the New York Stock Exchange on the
date fixed by the Board of Directors when the dividend or distribution is
declared.
DISTRIBUTION OPTIONS
When you fill out your Account Application, you can specify how you
want to receive your dividend distributions. Currently, there are five available
options:
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<PAGE> 36
1. REINVESTMENT OPTION. Your income and capital gain dividends, if any,
will be automatically reinvested in additional shares of a Fund. Income
and capital gain dividends will be reinvested at the net asset value of
the Fund as of the day after the record date. If you do not indicate a
choice on your Account Application, you will be assigned this option.
2. CASH OPTION. You will receive a check for each income or capital gain
dividend, if any. Distribution checks will be mailed no later than 7
days after the dividend payment date, which may be more than seven days
after the dividend record date.
3. INCOME EARNED OPTION. You will have your capital gain dividend
distributions, if any, reinvested automatically in a Fund at the NAV as
of the day after the record date, and have your income dividends paid
in cash.
4. DIRECTED DIVIDENDS OPTION. You will have income and capital gain
dividends, or only capital gain dividends, automatically reinvested in
shares of another Key Mutual Fund or Victory Portfolio. Shares will be
purchased at the NAV as of the day after the record date. If you are
reinvesting dividends of a fund sold without a sales charge in shares
of a fund sold with a sales charge, the shares will be purchased at the
public offering price. Dividend distributions can be directed only to
an existing account with a registration that is identical to that of
your Fund account.
5. DIRECTED BANK ACCOUNT OPTION. You will have your income and capital
gain dividends, or only your income dividends, automatically
transferred to your bank checking or savings account. The amount will
be determined on the dividend record date and will normally be
transferred to your account within seven days of the dividend record
date. Dividend distributions can be directed only to an existing
account with a registration that is identical to that of your Fund
account. Please call or write the Transfer Agent to learn more about
this dividend distribution option.
Any election or revocation of any of the above dividend distribution
options may be in writing to a Fund and sent to Key Mutual Funds, P.O. Box 8527,
Boston, MA 02266-8527, or by calling the Transfer Agent at 800-539-3863, and
will become effective with respect to dividends having record dates after
receipt of the Account Application or request by the Transfer Agent.
FEDERAL INCOME TAXES
Each Fund has qualified and intends to continue to qualify under
Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"), as a
regulated investment company so long as it is in the best interest of its
shareholders to do so. This qualification relieves each Fund (but not their
shareholders) from incurring federal income tax on taxable income which it
distributes to shareholders, assuming certain distribution and investment
requirements are met. These investment requirements may limit a Fund's ability
to dispose of shares of Underlying Portfolios held less than three months.
Dividends paid from net investment income and any net short-term capital gains
will be taxable as
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ordinary income and distributions from net long-term capital gains (the excess
of long-term capital gain over short-term capital loss) will be taxable as
capital gain to Fund shareholders, regardless of how long Fund shares are held.
Such dividends and capital gain distributions will generally be taxable to
recipient shareholders, irrespective of whether such payments are taken in cash
or automatically reinvested in Fund shares. Corporate shareholders may be
eligible for the dividends received deduction on the dividends paid by a Fund to
the extent that the Fund's income is derived from certain dividends received
from domestic corporations, as long as the corporate shareholder holds the Fund
share upon which the eligible dividends was paid for at least 46 days.
Generally, dividends and distribution of capital gains are taxable to
shareholders when paid. However, such dividends and distributions declared in
October, November or December and made payable to shareholders of record in such
a month are treated as paid and are thereby taxable as of December 31, provided
that such dividend and distributions are actually paid no later than January 31
of the following year. In addition, a 4% nondeductible excise tax will be
imposed on each Fund (other than to the extent of the Fund's tax-exempt income)
to the extent it does not meet certain minimum distribution requirements by the
end of each calendar year. Each Fund will either actually or be deemed to
distribute substantially all of its net investment income and net capital gains
by the end of each calendar year and, thus, expects not be subject to the excise
tax.
Dividends and capital gains distributions have the effect of reducing
the NAV per share by the amount distributed. Although a dividend or capital gain
distribution paid to a shareholder on newly issued or acquired Fund shares
shortly after purchase would represent, in substance, a return of capital, the
distribution would nevertheless be attributable to net investment income or net
realized capital gains, and therefore be taxable to the shareholder.
Any gain or loss realized upon a sale or redemption of Fund shares by a
shareholder who is not a dealer in securities will be treated as long-term
capital gain or loss if the shares have been held for more than one year.
Notwithstanding the above, any loss realized by a shareholder upon the sale of
shares in a Fund held six months or less will be treated as long-term capital
loss to the extent of any long-term capital gain distributions received by the
shareholder.
The Company will inform you of the amount and nature of dividends and
capital gains distributions in January of the following year. You should keep
all statements you receive to assist you in your record keeping. The Company may
be required to withhold, subject to certain exemptions, at the rate of 31% on
dividends, capital gain distributions and redemption proceeds (and deemed
proceeds from exchanges) paid or credited to a shareholder, unless the
shareholder provides a correct tax identification number (generally, the
shareholder's social security or employer identification number) and, upon
establishing an account with the Company, certifies on the account application
that the shareholder is not subject to backup withholding, or the IRS notifies
the Fund that the shareholder is subject to back-up withholding. Moreover,
failure to furnish a certified TIN to the Company could subject an investor to a
$50 penalty imposed by the IRS.
Dividends and distributions are generally subject to state and local
taxes. Shareholders are urged to consult their own tax advisers regarding
specific questions as to federal, state or local taxes.
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For additional tax-related information, see "Federal Income Taxes" in
the Statement of Additional Information.
PERFORMANCE
From time to time a Fund may advertise the "yield" and "total return"
of its shares. Yield and total return figures are based on historical earnings
and are not intended to indicate future performance. The yield on shares of a
Fund will be calculated by dividing the net investment income per share during a
recent 30-day (or one month) period by the maximum public offering price per
share of the Fund on the last day of that period. The results are compounded on
a bond equivalent (semiannual) basis and then annualized. The "total return" of
shares may be calculated on an average annual total return basis or an aggregate
total return basis. Average annual total return refers to the average annual
compounded rates of return on shares over one-, five-, and ten-year periods or
the life of the Fund (as stated in the advertisement) that would equate an
initial amount invested at the beginning of the stated period to the ending
redeemable value of the investment, assuming the reinvestment of all dividend
and capital gains distributions. Aggregate total return reflects the total
percentage change in the value of the investment over the measuring period,
again assuming the reinvestment of all dividends and capital gains
distributions. Total return may also be presented for other periods.
Investment performance, which will vary, is based on many factors,
including market conditions, the composition of the Fund's portfolio and such
Fund's operating expenses. Investment performance also often reflects the risks
associated with a Fund's investment objective and policies. These factors should
be considered when comparing a Fund's investment results to those of other
mutual funds and other investment vehicles. Since yields fluctuate, yield data
cannot necessarily be used to compare an investment in the Funds with bank
deposits, savings accounts and similar investment alternatives which often
provide for an agreed-upon or guaranteed fixed yield for a stated period of
time. Each Fund's annual report will contain additional performance information
and will be available without charge upon request.
See "Performance Information" in the Statement of Additional
Information for further information.
DESCRIPTION OF COMMON STOCK
The Company is an open-end, diversified management investment company,
incorporated under Maryland law on May 26, 1983. Pursuant to the Articles of
Incorporation, the Board of Directors may authorize the creation of additional
series of shares. Pursuant to such authority, the Board of Directors has
authorized the issuance of nine series of shares, each representing shares in
one of nine separate Funds: Growth Fund (1 billion authorized shares); Moderate
Growth Fund (1 billion authorized shares); Conservative Growth Fund (1 billion
authorized shares); Stock Index Fund (1 billion authorized shares);
International Index Fund (1 billion authorized shares); SBSF Fund (25 million
authorized shares); SBSF Convertible Securities Fund (25 million authorized
shares); SBSF Capital Growth Fund (25 million authorized shares) and SBSF Money
Market
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<PAGE> 39
Fund (175 million authorized shares). The par value of the shares of each of the
Funds is $.01 per share. The assets of each Fund are segregated and separately
managed and a shareholder's interest is in the assets and earnings of the Fund
in which he or she holds shares. Each share of a Fund represents an equal
proportionate interest in that portfolio with each other share of the same
series. In the event of the liquidation or dissolution of the Company, shares of
a Fund are entitled to receive the assets belonging to that portfolio that are
available for distribution and a proportionate distribution, based upon the
relative net assets of the respective Funds, of any general assets not belonging
to any particular portfolio that are available for distribution. Shareholders
are entitled to one vote for each share held and will vote in the aggregate and
not by portfolio except as otherwise required by the 1940 Act or Maryland law.
It is anticipated that the Company will not hold annual shareholder meetings
except when required to do so by the 1940 Act or Maryland law.
CUSTODIAN, TRANSFER AGENT AND DIVIDEND DISBURSING AGENT
Key Trust Company of Ohio, N.A., 127 Public Square, Cleveland, Ohio
44114, is the Custodian for the Funds' cash and securities. Key Trust Company of
Ohio, N.A. does not assist in any way, and is not responsible for, investment
decisions involving assets of the Funds. Key Trust Company of Ohio, N.A. is a
subsidiary of KeyCorp and an affiliate of the Adviser and receives compensation
from the Funds for the services it performs as Custodian. State Street Bank and
Trust Company, 225 Franklin Street, Boston, MA 02110, is the Transfer Agent for
the shares of the Funds and receives a fee for this service. Boston Financial
Data Services, Inc., Two Heritage Drive, Quincy, MA 02171, acts as the Dividend
Disbursing Agent for the shares of the Funds and receives a fee for this
service.
SHAREHOLDER REPORTS
The Funds will prepare and send to shareholders unaudited semi-annual
and audited annual reports which will include a list of the Underlying Portfolio
shares and other investment securities held by each of the Funds. The Funds
intend to eliminate duplicate mailings of Reports to an address which more than
one shareholder of record with the same last name has indicated that mail is to
be delivered. Shareholders may receive additional copies of any Report at no
cost by writing to the Funds at the below address or by calling 800-539-3863. In
addition, shareholders of the Funds will receive, monthly, a cumulative account
statement for the calendar year.
Shareholder inquiries should be addressed to the Funds at Key Mutual
Funds, P.O. Box 8527, Boston, MA 02266-8527. Shareholders may also call the
Funds at 800-539-3863.
- ------------------------------------------------------------------------------
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS IN CONNECTION WITH THE OFFERING
MADE BY THIS PROSPECTUS, AND IF GIVEN OR MADE, SUCH INFORMATION OR
REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY KEY MUTUAL
FUNDS OR THE DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE
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AN OFFERING BY KEY MUTUAL FUNDS OR BY THE DISTRIBUTOR IN ANY JURISDICTION IN
WHICH SUCH OFFERING MAY NOT LAWFULLY BE MADE.
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<PAGE> 41
KEY MUTUAL FUNDS
45 Rockefeller Plaza
New York, New York 10111
INVESTMENT ADVISER
KeyCorp Mutual Fund Advisers, Inc.
127 Public Square
Cleveland, Ohio 44114
DISTRIBUTOR AND ADMINISTRATOR
BISYS Fund Services
3435 Stelzer Road
Columbus, Ohio 43219
COUNSEL
Morrison & Foerster LLP
2000 Pennsylvania Avenue, NW
Washington, DC 20006
INDEPENDENT ACCOUNTANTS
Price Waterhouse LLP
1177 Avenue of the Americas
New York, New York 10036
CUSTODIAN
Key Trust Company of Ohio, N.A.
127 Public Square
Cleveland, Ohio 44114
TRANSFER AGENT
State Street Bank and Trust Company
225 Franklin Street
Boston, MA 02110
The date of this Prospectus is August __, 1996
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<PAGE> 42
KEY MUTUAL FUNDS
KEY GROWTH FUND
KEY MODERATE GROWTH FUND
KEY CONSERVATIVE GROWTH FUND
STATEMENT OF ADDITIONAL INFORMATION
AUGUST , 1996
This Statement of Additional Information is not a prospectus and should be read
in conjunction with the Prospectus of Key Mutual Funds, dated August , 1996, as
supplemented from time to time. This Statement of Additional Information is
incorporated by reference in its entirety into the Prospectus for the Key Growth
Fund, Key Moderate Growth Fund and Key Conservative Growth Fund. Copies of the
Prospectus may be obtained by writing to Key Mutual Funds at P.O. Box 8527,
Boston, MA 02266-8527, or by telephoning toll free 800-539-3863.
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<PAGE> 43
TABLE OF CONTENTS
<TABLE>
<S> <C>
INVESTMENT OBJECTIVES AND POLICIES 3
Additional Information on Fund Investments
Additional Information Regarding Certain of the
Proprietary Portfolios' Investments
INVESTMENT RESTRICTIONS OF THE FUNDS 25
PORTFOLIO TURNOVER 28
MANAGEMENT OF THE FUNDS 29
Management of the Proprietary Portfolios
THE INVESTMENT ADVISER OF THE FUNDS 36
The Investment Adviser of the Proprietary Portfolios
ADMINISTRATOR OF THE FUNDS 39
EXPENSES, DISTRIBUTOR AND DISTRIBUTION PLAN 40
SHAREHOLDER SERVICING PLAN 42
CUSTODIAN, TRANSFER AGENT AND DIVIDEND DISBURSING AGENT 43
PERFORMANCE INFORMATION 43
PORTFOLIO TRANSACTIONS AND BROKERAGE 47
PURCHASE, REDEMPTION AND PRICING 48
FEDERAL INCOME TAXES 49
ADDITIONAL INFORMATION 53
INDEPENDENT ACCOUNTANTS AND REPORTS 54
COUNSEL 54
APPENDIX A 55
</TABLE>
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<PAGE> 44
INVESTMENT OBJECTIVES AND POLICIES
Key Mutual Funds, formerly known as SBSF Funds, Inc. (the "Company") is
a professionally managed, no-load, open-end series investment company consisting
of several different portfolios, three of which (each a "Fund" and,
collectively, the "Funds") are described in this Statement of Additional
Information. Each Fund is a separately managed, diversified mutual fund with its
own investment objective and policies. The Funds have no sales loads, redemption
fees or exchange fees. Each Fund has been constructed as a "fund of funds,"
which means that it pursues its investment objective primarily by allocating its
investments among Key Mutual Funds (sometimes "KMF") and The Victory Portfolios
(sometimes "VP") (the "Proprietary Portfolios"). The Funds also may invest a
portion of their assets in shares of investment companies that are not
affiliated with the Funds (the "Other Portfolios"). (Proprietary Portfolios and
Other Portfolios are sometimes referred to herein as "Underlying Portfolios.")
The three Funds and their investment objectives are:
KEY GROWTH FUND
The investment objective of the Key Growth Fund (the "Growth Fund") is
to seek to provide growth of capital. The Growth Fund seeks to achieve its
objective by allocating its assets primarily among Underlying Portfolios that
invest primarily in stocks.
KEY MODERATE GROWTH FUND
The investment objective of the Key Moderate Growth Fund (the "Moderate
Growth Fund") is to seek to provide growth of capital combined with a moderate
level of current income. The Moderate Growth Fund seeks to achieve its objective
by allocating its assets among Underlying Portfolios that invest in stocks and,
to a lesser extent, fixed income securities.
KEY CONSERVATIVE GROWTH FUND
The investment objective of the Key Conservative Growth Fund (the
"Conservative Growth Fund") is to seek to provide current income combined with
moderate growth of capital. The Conservative Growth Fund seeks to achieve its
objective by allocating its assets among Underlying Portfolios that invest in
fixed income securities and, to a lesser extent, stocks.
ADDITIONAL INFORMATION ON FUND INVESTMENTS
Pursuant to an Exemptive Order issued by the Securities and Exchange
Commission (the "SEC") (Investment Company Act Release No. ____ of _______,
1996), the Funds may invest up to 100% of their assets in investment portfolios
of KMF and of VP, which, collectively, have in excess of twenty-five portfolios
(the "Proprietary Portfolios"). A portion (up to 20%) of each Fund's assets may
be invested in shares of non-proprietary mutual funds (the "Other Portfolios")
that are not part of the same group of investment companies as the Funds. A Fund
and its affiliates, collectively, may acquire no more than 3% of the total
outstanding stock of any Other Portfolio.
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Because of their investment objectives and policies, these Funds will
concentrate more than 25% of their assets in the mutual fund industry. However,
each of the Proprietary Portfolios and Other Portfolios (collectively, the
"Underlying Portfolios") in which the Funds invest does not concentrate 25% or
more of its assets in any one industry.
The Prospectus more fully addresses the subject of each Fund's and each
Proprietary Portfolio's investment objectives, as well as the investment
policies that the Funds apply in seeking to meet those objectives. The following
disclosures will supplement that information more specifically by detailing the
types of securities and other instruments in which the Proprietary Portfolios
may invest, the strategies and the risks behind such investing. Note that there
can be no assurance given that the respective investment objectives of the Funds
or the Proprietary Portfolios will be achieved.
KEY MUTUAL FUNDS:
SBSF FUND. The Fund seeks to provide a high total return over the long-term
consistent with reasonable risk. In pursuing its objective, the SBSF Fund
invests primarily in common stocks which, in the opinion of the Adviser, have
the potential for capital appreciation in excess of market averages during
periods of market strength while attempting to preserve capital during periods
of market weakness.
SBSF CONVERTIBLE SECURITIES FUND. The Fund seeks to provide a high level of
current income together with long-term capital appreciation. The SBSF
Convertible Securities Fund invests primarily in convertible bonds, corporate
notes, convertible preferred stocks and other securities convertible into common
stock.
SBSF CAPITAL GROWTH FUND. The Fund seeks to provide capital appreciation. The
SBSF Capital Growth Fund seeks to achieve its objective by investing in equity
securities of companies which the Adviser believes are likely to have rapid
growth in earnings or cash flow. The SBSF Capital Growth Fund invests primarily
in the securities of small to medium capitalization companies.
VICTORY PORTFOLIOS:
VALUE FUND. The Fund seeks to provide long-term growth of capital and dividend
income. The Fund pursues this objective by investing primarily in a diversified
group of common stocks with an emphasis on companies with above average total
return potential.
DIVERSIFIED STOCK FUND. The Fund seeks to provide long-term growth of capital.
The Fund pursues this investment objective by investing primarily in common
stocks and securities convertible into common stocks issued by established
domestic and foreign companies.
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<PAGE> 46
GROWTH FUND. The Fund seeks to provide long-term growth of capital. The Fund
pursues this objective by investing primarily in common stocks of issuers listed
on a nationally recognized exchange with an emphasis on companies with superior
prospects for long-term earnings growth and price appreciation.
SPECIAL VALUE FUND. The Fund seeks to provide long-term growth of capital and
dividend income. The Fund pursues this objective by investing primarily in
common stocks of small and medium-sized companies listed on a nationally
recognized exchange with an emphasis on companies with above average total
return potential.
SPECIAL GROWTH FUND. The Fund seeks to provide capital appreciation. The Fund
pursues this investment objective by investing primarily in equity securities of
companies that have market capitalizations of $750 million or less at the time
of purchase.
OHIO REGIONAL STOCK FUND. The Fund seeks to provide capital appreciation. The
Fund pursues this objective by investing primarily in common stocks and
securities convertible into common stocks issued by companies whose headquarters
are located in the State of Ohio. The Fund's policy of concentrating its
investments in the State of Ohio means that its assets may be subject to greater
risk from economic, political or other developments having an unfavorable impact
upon the State of Ohio. Moreover, because of the geographic location, the Fund
may be less varied (by industry and by issuer) than other funds with similar
investment objectives and no such geographic limitation.
INTERNATIONAL GROWTH FUND. The Fund seeks to provide capital growth consistent
with reasonable investment risk. The Fund pursues this objective by investing
primarily in equity securities of foreign corporations, most of which will be
denominated in foreign currencies.
LIMITED TERM INCOME FUND. The Fund seeks to provide income consistent with
limited fluctuation of principal. The Fund pursues this objective by investing
in a portfolio of high grade, fixed income securities with a dollar-weighted
average maturity of one to five years, based on remaining maturities.
INVESTMENT QUALITY BOND FUND. The Fund seeks to provide a high level of income.
The Fund pursues this objective by investing primarily in investment-grade bonds
issued by corporations and the U.S. Government and its agencies or
instrumentalities.
FUND FOR INCOME. The Fund seeks to provide a high level of current income
consistent with preservation of shareholders' capital. The Fund pursues this
objective by investing primarily in selected mortgage-related securities.
FINANCIAL RESERVES FUND. The Fund seeks to obtain as high a level of current
income as is consistent with preserving capital and providing liquidity. The
Fund pursues this investment objective by investing primarily in a portfolio of
high-quality U.S. denominated money market instruments. The Fund seeks to
maintain a constant net asset value of $1.00 per unit of beneficial interest,
and shares of the Fund are offered at net asset value.
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<PAGE> 47
SHORT-TERM OBLIGATIONS. While the Funds each will normally be
predominantly invested in shares of other mutual funds, there may be times when,
in the opinion of KMFA, market conditions warrant that, for temporary defensive
purposes, a Fund may invest without limitation in short-term obligations. To the
extent that a Fund's assets are so invested, they will not be invested so as to
meet its investment objective. The instruments may include high quality liquid
debt securities such as commercial paper, certificates of deposit, bankers'
acceptances, repurchase agreements with maturities of less than seven days and
United States Treasury bills. These instruments are described below in the
section of this Statement of Additional Information describing the permissible
investments of the Proprietary Portfolios.
ADDITIONAL INFORMATION REGARDING CERTAIN OF THE PROPRIETARY PORTFOLIOS'
INVESTMENTS
The following policies supplement the descriptions of the investment
objectives and policies of the Proprietary Portfolios as set forth above and in
the Prospectus.
BANKERS' ACCEPTANCES AND CERTIFICATES OF DEPOSIT. Certain of the
Proprietary Portfolios may invest in bankers' acceptances, certificates of
deposit, and demand and time deposits. Bankers' acceptances are negotiable
drafts or bills of exchange, 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 are negotiable certificates issued against
funds deposited in a commercial bank or a savings and loan association for a
definite period of time and earn a specified return.
Bankers' acceptances will be those guaranteed by domestic and foreign
banks, if at the time of purchase such banks have capital, surplus, and
undivided profits in excess of $100,000,000 (as of the date of their most
recently published financial statements). Certificates of deposit and demand and
time deposits will be those of domestic and foreign banks and savings and loan
associations, if (a) at the time of purchase such financial institutions have
capital, surplus, and undivided profits in excess of $100,000,000 (as of the
date of their most recently published financial statements) or (b) the principal
amount of the instrument is insured in full by the Federal Deposit Insurance
Corporation or the Savings Association Insurance Fund.
Certain of the Proprietary Portfolios also may invest in Eurodollar
Certificates of Deposit ("ECDs") which are U.S. dollar-denominated certificates
of deposit issued by branches of foreign and domestic banks located outside the
United States, Yankee Certificates of Deposit ("Yankee CDs") which are
certificates of deposit issued by a U.S. branch of a foreign bank denominated in
U.S. dollars and held in the United States, Eurodollar Time Deposits ("ETDs")
which are U.S. dollar-denominated deposits in a foreign branch of a U.S. bank or
a foreign bank, and Canadian Time Deposits ("CTDs") which are U.S.
dollar-denominated certificates of deposit insured by Canadian offices of major
Canadian Banks.
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<PAGE> 48
COMMERCIAL PAPER. Certain of the Proprietary Portfolios may purchase
commercial paper. Commercial paper consists of unsecured promissory notes issued
by corporations. Except as noted below with respect to variable amount master
demand notes, issues of commercial paper normally have maturities of less than
nine months and fixed rates of return.
Certain of the Proprietary Portfolios will purchase only commercial
paper rated in one of the two highest categories at the time of purchase by a
nationally recognized statistical rating organization ("NRSRO") or, if not
rated, determined by the Company's Board of Directors to present minimal credit
risks and to be of comparable investment quality to instruments that are rated
high quality (i.e., in one of the two top ratings categories) by a NRSRO that is
neither controlling, controlled by, or under common control with the issuer of,
or any issuer, guarantor, or provider of credit support for, the instruments.
For a description of the rating symbols of each NRSRO see the Appendix
to this Statement of Additional Information.
VARIABLE AMOUNT MASTER DEMAND NOTES. Certain of the Proprietary
Portfolios may purchase variable amount master demand notes, which are unsecured
demand notes that permit the indebtedness thereunder to vary and provide for
periodic adjustments in the interest rate according to the terms of the
instrument. Although there is no secondary market for these notes, a Proprietary
Portfolio may demand payment of principal and accrued interest at any time and
may resell the notes at any time to a third party. The absence of an active
secondary market, however, could make it difficult for a Proprietary Portfolio
to dispose of a variable amount master demand note if the issuer defaulted on
its payment obligations, and a Proprietary Portfolio could, for this or other
reasons, suffer a loss to the extent of the default. While the notes are not
typically rated by credit rating agencies, issuers of variable amount master
demand notes must satisfy the same criteria as set forth above for unrated
commercial paper, and the Proprietary Portfolios' Adviser will continuously
monitor the issuer's financial status and ability to make payments due under the
instrument. Where necessary to ensure that a note is of "high quality," a
Proprietary Portfolio will require that the issuer's obligation to pay the
principal of the note be backed by an unconditional bank letter or line of
credit, guarantee or commitment to lend. For purposes of a Proprietary
Portfolio's investment policies, a variable amount master note will be deemed to
have a maturity equal to the longer of the period of time remaining until the
next readjustment of its interest rate or the period of time remaining until the
principal amount can be recovered from the issuer through demand.
FOREIGN INVESTMENT. Certain of the Proprietary Portfolios may invest in
securities issued by foreign issuers. Such investments may subject a Proprietary
Portfolio to investment risks that differ in some respects from those associated
with investments in obligations of U.S. domestic issuers or in U.S. securities
markets. Such risks include future adverse political and economic developments,
possible seizure, nationalization, or expropriation of foreign investments, less
stringent disclosure requirements, the possible establishment of exchange
controls or taxation at the source, and the adoption of other foreign
governmental restrictions. Additional risks include currency exchange risks,
less publicly available information, the risk that companies may not be subject
to the accounting, auditing and financial reporting standards and requirements
of
7
<PAGE> 49
U.S. companies, the risk that foreign securities markets may have less volume
and therefore many securities traded in these markets may be less liquid and
their prices more volatile than U.S. securities, and the risk that custodian and
brokerage costs may be higher. Permissible investments include obligations or
securities of foreign issuers, foreign branches of U.S. banks and of foreign
banks.
U.S. GOVERNMENT OBLIGATIONS. Certain of the Proprietary Portfolios may
invest in obligations issued or guaranteed by the U.S. Government, its agencies
and instrumentalities. Obligations of certain agencies and instrumentalities of
the U.S. Government are supported by the full faith and credit of the U.S.
Treasury; others are supported by the right of the issuer to borrow from the
U.S. Treasury; others are supported by the discretionary authority of the U.S.
Government to purchase the agency's obligations; and still others are supported
only by the credit of the agency or instrumentality. No assurance can be given
that the U.S. Government will provide financial support to U.S.
Government-sponsored agencies or instrumentalities if it is not obligated to do
so by law. A Proprietary Portfolio will invest in obligations of such agencies
and instrumentalities only when its Adviser believes that the credit risk with
respect thereto is minimal. U.S. Government obligations are subject to interest
rate risks.
SECURITIES LENDING. Certain of the Proprietary Portfolios may lend
portfolio securities to broker-dealers, banks or institutional borrowers of
securities. A Proprietary Portfolio must receive a minimum of 100% collateral,
plus any interest due in the form of cash or U.S. Government securities. This
collateral must be valued daily and should the market value of the loaned
securities increase, the borrower must furnish additional collateral to the
Proprietary Portfolio. During the time portfolio securities are on loan, the
borrower will pay the Proprietary Portfolio any dividends or interest paid on
such securities plus any interest negotiated between the parties to the lending
agreement. Loans will be subject to termination by a Proprietary Portfolio or
the borrower at any time. While a Proprietary Portfolio will not have the right
to vote securities on loan, it intends to terminate the loan and regain the
right to vote if that is considered important with respect to the investment. A
Proprietary Portfolio will only enter into loan arrangements with
broker-dealers, banks or other institutions which its Adviser has determined are
creditworthy under guidelines established by the Company's Board of Directors.
VARIABLE AND FLOATING RATE NOTES. Certain of the Proprietary Portfolios
may acquire variable and floating rate notes, subject to the Proprietary
Portfolio's investment objective, policies and restrictions. A variable rate
note is one whose terms provide for the readjustment of its interest rate on set
dates and which, upon such readjustment, can reasonably be expected to have a
market value that approximates its par value. A floating rate note is one whose
terms provide for the readjustment of its interest rate whenever a specified
interest rate changes and which, at any time, can reasonably be expected to have
a market value that approximates its par value. Such notes are frequently not
rated by credit rating agencies; however, unrated variable and floating rate
notes purchased by the Proprietary Portfolio will only be those determined by
its Adviser, under guidelines established by the Company, to pose minimal credit
risks and to be of comparable quality, at the time of purchase, to rated
instruments eligible for purchase under the Proprietary Portfolio's investment
policies. In making such determinations, its Adviser will consider the earning
power, cash flow and other liquidity ratios of the issuers of such notes (such
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<PAGE> 50
issuers include financial, merchandising, bank holding and other companies) and
will continuously monitor their financial condition. Although there may be no
active secondary market with respect to a particular variable or floating rate
note purchased by the Proprietary Portfolio, the Proprietary Portfolio may
resell the note at any time to a third party. The absence of an active secondary
market, however, could make it difficult for the Proprietary Portfolio to
dispose of a variable or floating rate note in the event the issuer of the note
defaulted on its payment obligations and the Proprietary Portfolio could, for
this or other reasons, suffer a loss to the extent of the default. Variable or
floating rate notes may be secured by bank letters of credit.
Variable or floating rate notes may have maturities of more than one
year, as follows:
1. A note that is issued or guaranteed by the United States
government or any agency thereof and which has a variable rate of
interest readjusted no less frequently than annually will be
deemed by the Proprietary Portfolio to have a maturity equal to
the period remaining until the next readjustment of the interest
rate.
2. A variable rate note, the principal amount of which is scheduled
on the face of the instrument to be paid in one year or less, will
be deemed by the Proprietary Portfolio to have a maturity equal to
the period remaining until the next readjustment of the interest
rate.
3. A variable rate note that is subject to a demand feature scheduled
to be paid in one year or more will be deemed by the Proprietary
Portfolio to have a maturity equal to the longer of the period
remaining until the next readjustment of the interest rate or the
period remaining until the principal amount can be recovered
through demand.
4. A floating rate note that is subject to a demand feature will be
deemed by the Proprietary Portfolio to have a maturity equal to
the period remaining until the principal amount can be recovered
through demand.
As used above, a note is "subject to a demand feature" where the
Proprietary Portfolio is entitled to receive the principal amount of the note
either at any time on no more than 30 days' notice or at specified intervals not
exceeding one year and upon no more than 30 days' notice.
FORWARD FOREIGN CURRENCY CONTRACTS. Certain of the Proprietary
Portfolios may purchase and sell forward foreign currency contracts. Foreign
securities involve currency risks. The U.S. dollar value of a foreign security
tends to decrease when the value of the U.S. dollar rises against the foreign
currency in which the security is denominated, and tends to increase when the
value of the U.S. dollar falls against such currency. To hedge against foreign
exchange risk arising from a Proprietary Portfolio's investment or anticipated
investment in securities denominated in foreign currencies, the Proprietary
Portfolio may purchase and sell forward foreign currency contracts. To attempt
to minimize the risk to a Proprietary Portfolio from adverse changes in the
relationship between the U.S. dollar and foreign currencies, the Proprietary
Portfolio may purchase and sell forward foreign currency contracts. A forward
foreign currency contract (a "forward contract") is an obligation to purchase or
sell a specific currency for an
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<PAGE> 51
agreed price at a future date (usually less than one year), which is
individually negotiated and privately traded by currency traders and their
customers. A forward contract generally has no deposit requirement, and no
commissions are charged at any stage for trades. Although foreign exchange
dealers do not charge a fee for commissions, they do realize a profit based on
the difference between the price at which they are buying and selling various
currencies. Although these contracts are intended to minimize the risk of loss
due to a decline in the value of the hedged currencies, at the same time, they
tend to limit any potential gain which might result should the value of such
currencies increase.
While a Proprietary Portfolio may enter into forward contracts to
reduce currency exchange risks, changes in currency exchange rates may result in
poorer overall performance for the Proprietary Portfolio than if it had not
engaged in such transactions. Moreover, there may be an imperfect correlation
between a Proprietary Portfolio's investment portfolio holdings of securities
denominated in a particular currency and forward contracts entered into by the
Proprietary Portfolio. Such imperfect correlation may prevent the Proprietary
Portfolio from achieving the intended hedge or expose the Proprietary Portfolio
to the risk of currency exchange loss.
A Proprietary Portfolio will not enter into forward contracts or
maintain a net exposure to such contracts where the consummation of the
contracts would obligate the Proprietary Portfolio to deliver an amount of
currency in excess of the value of the Proprietary Portfolio's portfolio
securities or other assets denominated in that currency. Certain of the
Proprietary Portfolios also may purchase and sell options on foreign currencies
and foreign currency futures contracts and related options. (See "Options on
Foreign Currencies" and "Currency Futures" in this Statement of Additional
Information.)
A Proprietary Portfolio will hold cash, cash equivalents or U.S.
Government securities and other liquid assets in a segregated account with its
custodian in an amount equal (on a daily marked-to-market basis) to the amount
of the commitments under these contracts. At the maturity of a forward contract,
a Proprietary Portfolio may either accept or make delivery of the currency
specified in the contract, or prior to maturity, enter into a closing purchase
transaction involving the purchase or sale of an offsetting contract. Closing
purchase transactions with respect to forward contracts are usually effected
with the currency trader who is a party to the original forward contract. A
Proprietary Portfolio will only enter into such a forward contract if it is
expected that there will be a liquid market in which to close out the contract.
However, there can be no assurance that a liquid market will exist in which to
close a forward contract, in which case the Proprietary Portfolio may suffer a
loss.
Normally, consideration of the prospect for currency parities will be
incorporated in a longer term investment decision made with regard to overall
diversification strategies. However, the Adviser believes that it is important
to have the flexibility to enter into such forward contracts when it determines
that the best interest of a Proprietary Portfolio will be served. For example,
when a Proprietary Portfolio enters into a contract for the purchase or sale of
a security denominated in a foreign currency, it may desire to "lock in" the
U.S. dollar price of the security. By entering into a forward contract for the
purchase or sale of a fixed amount of foreign currency
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<PAGE> 52
for a fixed amount of U.S. dollars, a Proprietary Portfolio will be able to
hedge against the potential loss resulting from a change in the relationship
between the U.S. dollar and the subject foreign currency. This technique is used
during the period between the date on which a foreign security is purchased or
sold and the date on which payment for the foreign security or receipt of
foreign security is made or received and is sometimes referred to as a
"settlement hedge." This technique would also cause the Proprietary Portfolio to
forego any gain it might have realized had currency exchange rates moved in a
favorable direction.
When the Adviser believes that the currency of a particular foreign
country may suffer a substantial decline against the U.S. dollar, it may enter
into a forward contract to sell, for a fixed amount of dollars, the amount of
foreign currency approximating the value of some or all of a Proprietary
Portfolio's portfolio securities denominated in such foreign currency. Such a
hedge (sometimes referred to as a "position hedge") will tend to offset both
positive and negative currency fluctuations, but will not offset changes in
security values caused by other factors. A Proprietary Portfolio also may hedge
the same position by using another currency (or a basket of currencies) expected
to perform similarly to the hedged currency, when exchange rates between the two
currencies are sufficiently correlated ("proxy hedge"). The precise matching of
the forward contract amounts and the value of the securities involved will not
generally be possible since the future value of such securities in foreign
currencies will change as a consequence of market movements in the value of
those securities between the date the forward contract is entered into and the
date it matures. With respect to positions that constitute "transaction" or
"position hedges" (including "proxy hedges"), a Proprietary Portfolio will not
enter into forward contracts to sell currency or maintain a net exposure to such
contracts if the consummation of such contracts would obligate the Proprietary
Portfolio to deliver an amount of foreign currency in excess of the value of the
Proprietary Portfolio's portfolio securities or other assets denominated in that
currency (or the related currency, in the case of a proxy hedge).
Finally, a Proprietary Portfolio may enter into forward contracts to
shift its investment exposure from one currency into another currency that is
expected to perform better relative to the U.S. dollar. This type of strategy,
sometimes known as a "cross-hedge," will tend to reduce or eliminate exposure to
the currency that is sold, and increase exposure to the currency that is
purchased, much as if the Proprietary Portfolio had sold a security denominated
in one currency and purchased an equivalent security denominated in another.
Cross-hedges protect against losses resulting from a decline in the hedged
currency, but will cause the Proprietary Portfolio to assume the risk of
fluctuations in the value of the currency it purchases.
At the consummation of the forward contract, a Proprietary Portfolio
may either make delivery of the foreign currency or terminate its contractual
obligation to deliver the foreign currency by purchasing an offsetting contract
obligating it to purchase at the same maturity date the same amount of such
foreign currency. If the Proprietary Portfolio chooses to make delivery of the
foreign currency, it may be required to obtain such currency for delivery
through the sale of portfolio securities denominated in such currency or through
conversion of other assets of the Proprietary Portfolio into such currency. If
the Proprietary Portfolio engages in an offsetting transaction, the Proprietary
Portfolio will realize a gain or a loss to the extent that there has been a
change in forward contract prices. Closing purchase transactions with respect to
forward
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contracts are usually effected with the currency trader who is a party to the
original forward contract.
The Proprietary Portfolios' dealing in forward contracts will be
limited to the transactions described above. Of course, a Proprietary Portfolio
is not required to enter into such transactions with regard to its foreign
currency-denominated securities and will not do so unless deemed appropriate by
the Adviser. The Proprietary Portfolios generally will not enter into a forward
contract with a term of greater than one year.
A Proprietary Portfolio will place cash not available for investment or
liquid high grade debt securities (denominated in U.S. or foreign currency) in a
separate account in an amount equal to the value of the Proprietary Portfolio's
total assets committed to the consummation of forward currency exchange
contracts entered into with respect to "position hedges" or "cross hedges." If
the value of the securities placed in the separate account declines, additional
cash or securities will be placed in the account by the Proprietary Portfolio on
a daily basis so that the value of the account will equal the amount of the
Proprietary Portfolio's commitments with respect to such contracts. As an
alternative to maintaining all or a part of the separate account, a Proprietary
Portfolio may purchase a call option permitting the Proprietary Portfolio to
purchase the amount of foreign currency being hedged by a forward sale contract
at a price no higher than the forward contract price or a Proprietary Portfolio
may purchase a put option permitting the Proprietary Portfolio to sell the
amount of foreign currency subject to a forward purchase contract at a price as
high or higher that the forward contract price.
It should be realized that this method of protecting the value of the
Proprietary Portfolios' portfolio securities against a decline in the value of a
currency does not eliminate fluctuations in the underlying prices of the
securities. It simply establishes a rate of exchange which can be achieved at
some future point in time. It also reduces any potential gain which may have
otherwise occurred had the currency value increased above the settlement price
of the contract.
A Proprietary Portfolio's foreign currency transactions may be limited
by the requirements of Subchapter M of the Internal Revenue Code of 1986, as
amended, for qualification as a regulated investment company.
OPTIONS ON SECURITIES AND INDEXES. Certain of the Proprietary
Portfolios may purchase and sell ("write") call options on securities and
indexes. Similarly, certain of the Proprietary Portfolios may purchase and write
call and put options on securities and indexes. Some Proprietary Portfolios will
write only "covered" put and call options.
An option on a security (or index) is a contract that gives the holder
of the option, in return for a premium, the right to buy from (in the case of a
call) or sell to (in the case of a put) the writer of the option the security
underlying the option (or the cash value of the index) at a specified exercise
price at any time during the term of the option. The writer of an option on a
security has the obligation, upon exercise of the option, to deliver the
underlying security upon payment of the exercise price or to pay the exercise
price upon delivery of the underlying security. Upon exercise, the writer of an
option on an index is obligated to pay the difference between the
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cash value of the index and the exercise price multiplied by the specified
multiplier for the index option. (An index is designed to reflect specified
facets of a particular financial or securities market, a specific group of
financial instruments or securities, or certain economic indicators.) Options in
which certain of the Proprietary Portfolios may invest will be issued by the
Options Clearing Corporation and listed on a national securities exchange, while
some Proprietary Portfolios may invest in options traded in the over-the-counter
market.
A Proprietary Portfolio will write call options only if they are
"covered." A call option on a security is "covered" if the Proprietary Portfolio
owns the security underlying the call or has an absolute and immediate right to
acquire that security without additional cash consideration (or, if additional
cash consideration is required, cash or cash equivalents in such amount are
placed in a segregated account by its custodian) upon conversion or exchange of
other securities held by the Proprietary Portfolio. A call option on an index is
covered if the Proprietary Portfolio maintains with its custodian cash or cash
equivalents equal to the contract value. A call option also is covered if the
Proprietary Portfolio owns a call on the same security or index as the call
written where the exercise price of the call held is (1) 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 Proprietary
Portfolio in cash or cash equivalents in a segregated account with its
custodian. A put option on a security or an index is "covered" if the
Proprietary Portfolio maintains cash or cash equivalents equal to the exercise
price in a segregated account with its custodian. A put option also is covered
if the Proprietary Portfolio holds a put on the same security or index as the
put written where the exercise price of the put held is (i) equal to or greater
than the exercise price of the put written, or (ii) less than the exercise price
of the put written, provided the difference is maintained by the Fund in cash or
cash equivalents in a segregated account with its custodian.
If an option written by a Proprietary Portfolio expires, the
Proprietary Portfolio realizes a gain equal to the premium received at the time
the option was written. If an option purchased by a Proprietary Portfolio
expires unexercised, the Proprietary Portfolio realizes a loss equal to the
premium paid.
Prior to the earlier of exercise or expiration, an option may be closed
out by an offsetting purchase or sale of an option of the same series (type,
exchange, underlying security or index, exercise price, and expiration). There
can be no assurance, however, that a closing purchase or sale transaction can be
effected when the Proprietary Portfolio desires.
A Proprietary Portfolio will realize a gain from a closing purchase
transaction if the cost of the closing option is less than the premium received
from writing the option, or, if it is more, the Proprietary Portfolio will
realize a loss. If the premium received from a closing sale transaction is more
than the premium paid to purchase the option, the Proprietary Portfolio will
realize a loss. The principal factors affecting the market value of a put or
call option include the supply and demand, interest rates, the current market
price of the underlying security or index in relation to the exercise price of
the option, the volatility of the underlying security or index, and the time
remaining until the expiration date.
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The premium paid for a put or call option purchased by a Proprietary
Portfolio is an asset of the Proprietary Portfolio. The premium received for an
option written by a Proprietary Portfolio is recorded as a deferred credit. The
value of an option purchased or written is marked to market daily and is valued
at the closing price on the exchange on which it is traded or, if not traded on
an exchange or no closing price is available, at the mean between the last bid
and asked prices.
The staff of the Securities and Exchange Commission has taken the
position that purchased over-the-counter options and assets used to cover
written over-the-counter options are illiquid.
Risks Associated with Options on Securities and Indexes. The purchase
and writing of options involves certain risks. The writer of the option has no
control over the time when it may be required to fulfill its obligation as a
writer of the option. Once an option writer has received an exercise notice, it
cannot effect a closing purchase transaction in order to terminate its
obligation under the option and must deliver the underlying securities at the
exercise price. If a put or call option purchased by the Proprietary Portfolio
is not sold when it has remaining value, and if the market price of the
underlying security, in the case of a put, remains equal to or greater than the
exercise price, the Proprietary Portfolio will lose its entire investment in the
option. If a Proprietary Portfolio were unable to close out a covered call
option that it had written on a security, it would not be able to sell the
underlying security unless the option expired without exercise. Furthermore,
during the option period, the covered call writer has, in return for the premium
received for the option, given up the opportunity to profit from a price
increase in the underlying securities above the exercise price, but, as long as
its obligation as a writer continues, has retained the risk of loss should the
price of the underlying security decline. In addition, except to the extent that
a call option on an index written by a Proprietary Portfolio is covered by an
option on the same index purchased by the Proprietary Portfolio, movements in
the index may result in a loss to the Proprietary Portfolio.
There can be no assurance that a liquid market will exist when a
Proprietary Portfolio seeks to close out an option position. Additionally, if
trading restrictions or suspensions are imposed on the options markets, a
Proprietary Portfolio may be unable to close out a position. The writing of call
options could result in increases in a Proprietary Portfolio's portfolio
turnover rate, particularly during periods when market prices of the underlying
securities appreciate.
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.
Moreover, there are significant differences between the securities and options
markets that could result in an imperfect correlation between these markets,
causing a given transaction not to achieve its objectives.
OPTIONS ON FOREIGN CURRENCIES. Certain of the Proprietary Portfolios
may purchase and sell ("write") put and call options on foreign currencies,
either on exchanges or in the over-the-counter market. A put option on a foreign
currency gives the purchaser of the option the right to sell a foreign currency
at the exercise price until the option expires. A call option on a
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foreign currency gives the purchaser of the option the right to purchase the
currency at the exercise price until the option expires. Currency options traded
on U.S. or other exchanges may be subject to position limits which may limit the
ability of a Proprietary Portfolio to reduce foreign currency risk using such
options. Over-the-counter options differ from traded options in that they are
two-party contracts with price and other terms negotiated between the buyer and
seller, and generally do not have as much market liquidity as exchange-traded
options.
A Proprietary Portfolio may purchase and sell options on foreign
currencies for hedging purposes. For example, a decline in the dollar value of a
foreign currency in which portfolio securities are denominated will reduce the
dollar value of such securities, even if their value in the foreign currency
remains constant. In order to protect against such diminutions in the value of
portfolio securities, a Proprietary Portfolio may purchase put options on the
foreign currency. If the value of the currency does decline, that Proprietary
Portfolio will have the right to sell such currency for a fixed amount of
dollars which exceeds the market value of such currency, resulting in a gain
that may offset, in whole or in part, the negative effect of currency
depreciation on the value of the Proprietary Portfolio's securities denominated
in that currency.
Conversely, if a rise in the dollar value of a foreign currency in
which securities to be acquired are denominated is projected, thereby increasing
the cost of such securities, a Proprietary Portfolio may purchase call options
on such currency. If the value of such currency does increase, the purchase of
such call options would enable the Proprietary Portfolio to purchase currency
for a fixed amount of dollars which is less than the market value of such
currency, resulting in a gain that may offset, at least partially, the effect of
any currency-related increase in the price of securities the Proprietary
Portfolio intends to acquire. As in the case of other types of options
transactions, however, the benefit the Proprietary Portfolio derives from
purchasing foreign currency options will be reduced by the amount of the premium
and related transaction costs. In addition, if currency exchange rates do not
move in the direction or to the extent anticipated, the Proprietary Portfolio
could sustain losses on transactions in foreign currency options which would
deprive it of a portion or all of the benefits of advantageous changes in such
rates.
A Proprietary Portfolio also may write options on foreign currencies
for hedging purposes. For example, if the Proprietary Portfolio anticipates a
decline in the dollar value of foreign currency-denominated securities due to
declining exchange rates, it could, instead of purchasing a put option, write a
call option on the relevant currency. If the expected decline occurs, the option
will most likely not be exercised, and the diminution in value of portfolio
securities will be offset by the amount of the premium received by the
Proprietary Portfolio.
Similarly, instead of purchasing a call option to hedge against an
anticipated increase in the dollar cost of securities to be acquired, a
Proprietary Portfolio could write a put option on the relevant currency. If
rates move in the manner projected, the put option will expire unexercised and
allow the Fund to offset such increased cost up to the amount of the premium. As
in the case of other types of options transactions, however, the writing of a
foreign currency option will constitute only a partial hedge up to the amount of
the premium, and only if rates move in the expected direction. If unanticipated
exchange rate fluctuations occur, the option may be exercised and the
Proprietary Portfolio would be required to purchase or sell the underlying
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currency at a loss which may not be fully offset by the amount of the premium.
As a result of writing options on foreign currencies, the Proprietary Portfolio
also may be required to forego all or a portion of the benefits which might
otherwise have been obtained from favorable movements in currency exchange
rates.
A call option written on foreign currency by a Proprietary Portfolio is
"covered" if the Proprietary Portfolio owns the underlying foreign currency
subject to the call or securities denominated in that currency or has an
absolute and immediate right to acquire that foreign currency without additional
cash consideration (or for additional cash consideration held in a segregated
account by its custodian) upon conversion or exchange of other foreign currency
held in its portfolio. A call option is also covered if the Proprietary
Portfolio holds a call on the same foreign currency for the same principal
amount as the call written where the exercise price of the call held (a) is
equal to or less than the exercise price of the call written or (b) is greater
than the exercise price of the call written if the amount of the difference is
maintained by a Proprietary Portfolio in cash and liquid high grade debt
securities in a segregated account with its custodian.
FUTURES TRANSACTIONS. A futures contract is an agreement to buy or sell
a security or currency (or to deliver a final cash settlement price in the case
of a contract relating to an index or otherwise not calling for physical
delivery at the end of trading in the contracts), for a set price in a future
month. Certain of the Proprietary Portfolios may enter into stock index futures
contracts and futures contracts based on foreign currencies. Some Proprietary
Portfolios also may use foreign currency futures contracts and related options
for the purpose of hedging against changes in currency exchange rates or to
enhance returns.
Certain of the Proprietary Portfolios also may purchase and write put
and call options on futures contracts of the type into which such Proprietary
Portfolio is authorized to enter and may engage in related closing transactions.
In the United States, all such futures on securities, stock index futures,
foreign currency futures and related options will be traded on exchanges that
are regulated by the Commodity Futures Trading Commission ("CFTC"). Subject to
compliance with applicable CFTC rules, certain of the Proprietary Portfolios
also may enter into futures contracts traded on foreign futures exchanges as
long as trading on the aforesaid foreign futures exchanges does not subject the
Proprietary Portfolio to risks that are materially greater than the risks
associated with trading on U.S. exchanges. In the United States, futures
contracts are traded on boards of trade which have been designated "contract
markets" by the CFTC. Futures contracts trade on these markets through an "open
outcry" auction on the exchange floor. Currently, there are futures contracts
based on a variety of instruments, indexes and currencies.
When a purchase or sale of a futures contract is made by a Proprietary
Portfolio, the Proprietary Portfolio is required to deposit with its custodian
(or broker, if legally permitted) a specified amount of cash or U.S. Government
securities ("initial margin"). The margin required for a futures contract is set
by the exchange on which the contract is traded and may be modified during the
term of the contract. The initial margin requirement may be as low as 2% or less
of a contract's face value. The initial margin is in the nature of a performance
bond or good faith deposit on the futures contract which is returned to the
Proprietary Portfolio upon termination of the contract assuming all contractual
obligations have been satisfied. Each Proprietary Portfolio
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expects to earn interest income on its initial margin deposits. A futures
contract held by a Proprietary Portfolio is valued daily at the official
settlement price of the exchange on which it is traded. Each day the Proprietary
Portfolio pays or receives cash, called "daily settlement," equal to the daily
change in value of the futures contract. This process is known as "marking to
market." Variation margin does not represent a borrowing or loan by a
Proprietary Portfolio but is instead a settlement between the Proprietary
Portfolio and the broker of the amount one would owe the other if the futures
contract expired. In computing daily net asset value, each Proprietary Portfolio
will mark to market its open futures positions.
A Proprietary Portfolio is also required to deposit and maintain margin
with respect to put and call options on futures contracts written by it. Such
margin deposits will vary depending on the nature of the underlying futures
contract (and the related initial margin requirements), the current market value
of the option, and other futures positions held by the Proprietary Portfolio.
Positions taken in the futures markets are not normally held until
delivery or final cash settlement is required, but are instead liquidated
through offsetting transactions which may result in a gain or a loss. While
futures positions taken by a Proprietary Portfolio will usually be liquidated in
this manner, the Fund may instead make or take delivery of underlying securities
(or currencies) whenever it appears economically advantageous to the Proprietary
Portfolio to do so. A clearing organization associated with the exchange on
which futures are traded assumes responsibility for closing-out transactions and
guarantees that as between the clearing members of the exchange, the sale and
purchase obligations will be performed with regard to all positions that remain
open at the termination of the contract.
STOCK INDEX FUTURES. A stock index futures contract does not require
the physical delivery of securities, but merely provides for profits and losses
resulting from changes in the market value of the contract to be credited or
debited at the close of each trading day to the respective accounts of the
parties to the contract. On the contract's expiration date a final cash
settlement occurs and the futures positions are simply closed out. Changes in
the market value of a particular stock index futures contract reflect changes in
the specified index of equity securities on which the contract is based. A stock
index is designed to reflect overall price trends in the market for equity
securities.
CURRENCY FUTURES. Certain of the Proprietary Portfolios may purchase
and sell futures contracts on foreign currencies. A sale of a currency futures
contract creates an obligation by the Proprietary Portfolio, as seller, to
deliver the amount of currency called for in the contract at a specified future
time for a specified price. A purchase of a currency futures contract creates an
obligation by the Proprietary Portfolio, as purchaser, to take delivery of an
amount of currency at a specified future time at a specified price. The
Proprietary Portfolio may sell a currency futures contract if the Adviser
anticipates that exchange rates for a particular currency will fall, as a hedge
against a decline in the value of the Proprietary Portfolio's securities
denominated in such currency. If the Adviser anticipates that exchange rates
will rise, the Proprietary Portfolio may purchase a currency futures contract to
protect against an increase in the price of securities denominated in a
particular currency the Proprietary Portfolio intends to purchase. Although the
terms of currency futures contracts specify actual delivery or receipt, in most
instances the
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contracts are closed out before the settlement date without the making or taking
of delivery of the currency. Closing out of a currency futures contract is
effected by entering into an offsetting purchase or sale transaction. To offset
a currency futures contract sold by the Proprietary Portfolio, the Proprietary
Portfolio purchases a currency futures contract for the same aggregate amount of
currency and delivery date. If the price in the sale exceeds the price in the
offsetting purchase, the Proprietary Portfolio is immediately paid the
difference. Similarly, to close out a currency futures contract purchased by the
Proprietary Portfolio, the Proprietary Portfolio sells a currency futures
contract. If the offsetting sale price exceeds the purchase price, the
Proprietary Portfolio realizes a gain, and if the offsetting sale price is less
than the purchase price, the Proprietary Portfolio realizes a loss.
A risk in employing currency futures contracts to protect against the
price volatility of portfolio securities denominated in a particular currency is
that changes in currency exchange rates or in the value of the futures position
may correlate imperfectly with changes in the cash prices of a Proprietary
Portfolio's securities. The degree of correlation may be distorted by the fact
that the currency futures market may be dominated by short-term traders seeking
to profit from changes in exchange rates. This would reduce the value of such
contracts for hedging purposes over a short-term period. Such distortions are
generally minor and would diminish as the contract approached maturity. Another
risk is that an Adviser could be incorrect in its expectation as to the
direction or extent of various exchange rate movements or the time span within
which the movements take place.
OPTIONS ON FUTURES. For bona fide hedging and other appropriate risk
management purposes, certain of the Proprietary Portfolios purchase and write
call and put options on futures contracts which are traded on exchanges that are
licensed and regulated by the CFTC for the purpose of options trading, or,
subject to applicable CFTC rules, on foreign exchanges. A "call" option on a
futures contract gives the purchaser the right, in return for the premium paid,
to purchase a futures contract (assume a "long" position) at a specified
exercise price at any time before the option expires. A "put" option gives the
purchaser the right, in return for the premium paid, to sell a futures contract
(assume a "short" position), for a specified exercise price at any time before
the option expires. The writer of an option on a futures contract, unlike the
holder, is subject to initial margin and variation margin requirements on the
option position.
Upon the exercise of a "call," the writer of the option is obligated to
sell the futures contract (to deliver a "long" position to the option holder) at
the option exercise price, which will presumably be lower than the current
market price of the contract in the futures market. Upon exercise of a "put,"
the writer of the option is obligated to purchase the futures contract (deliver
a "short" position to the option holder) at the option exercise price, which
will presumably be higher than the current market price of the contract in the
futures market. When an entity exercises an option and assumes a long futures
position, in the case of a "call," or a short futures position, in the case of a
"put," its gain will be credited to its futures margin account, while the loss
suffered by the writer of the option will be debited to its account. However, as
with the trading of futures, most participants in the options markets do not
seek to realize their gains or losses by exercise of their option rights.
Instead, the writer or holder of an option will usually
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realize a gain or loss by buying or selling an offsetting option at a market
price that will reflect an increase or a decrease from the premium originally
paid.
Options on futures contracts can be used by a Proprietary Portfolio to
hedge substantially the same risks and for the same duration and risk management
purposes as might be addressed or served by the direct purchase or sale of the
underlying futures contracts. If the Proprietary Portfolio purchases an option
on a futures contract, it may obtain benefits similar to those that would result
if it held the futures position itself.
The purchase of put options on futures contracts is a means of hedging
a Proprietary Portfolio's portfolio against the risk of declining securities
prices or declining exchange rates for a particular currency. The purchase of a
call option on a futures contract represents a means of hedging against a market
advance affecting securities prices or currency exchange rates when the
Proprietary Portfolio is not fully invested. Depending on the pricing of the
option compared to either the futures contract upon which it is based or upon
the price of the underlying securities or currencies, it may or may not be less
risky than ownership of the futures contract or underlying securities or
currencies.
In contrast to a futures transaction, in which only transaction costs
are involved, benefits received in an option transaction will be reduced by the
amount of the premium paid as well as by transaction costs. In the event of an
adverse market movement, however, the Proprietary Portfolio will not be subject
to a risk of loss on the option transaction beyond the price of the premium it
paid plus its transaction costs, and may consequently benefit from a favorable
movement in the value of its portfolio securities or the currencies in which
such securities are denominated that would have been more completely offset if
the hedge had been effected through the use of futures.
If a Proprietary Portfolio writes options on futures contracts, the
Proprietary Portfolio will receive a premium but will assume a risk of adverse
movement in the price of the underlying futures contract comparable to that
involved in holding a futures position. If the option is not exercised, the
Proprietary Portfolio will realize a gain in the amount of the premium, which
may partially offset unfavorable changes in the value of securities held by or
to be acquired for the Proprietary Portfolio. If the option is exercised, the
Proprietary Portfolio will incur a loss in the option transaction, which will be
reduced by the amount of the premium it has received, but which may partially
offset favorable changes in the value of its portfolio securities or the
currencies in which such securities are denominated.
The writing of a call option on a futures contract constitutes a
partial hedge against declining prices of the underlying securities or the
currencies in which such securities are denominated. If the futures prices at
expiration is below the exercise price, the Proprietary Portfolio will retain
the full amount of the option premium, which provides a partial hedge against
any decline that may have occurred in the Proprietary Portfolio's holdings of
securities or the currencies in which such securities are denominated.
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The writing of a put option on a futures contract is analogous to the
purchase of a futures contract. For example, if a Proprietary Portfolio writes a
put option on a futures contract on securities related to securities that the
Proprietary Portfolio expects to acquire and the market price of such securities
increases, the net cost to a Proprietary Portfolio of the securities acquired by
it will be reduced by the amount of the option premium received. Of course, if
market prices have declined, the Proprietary Portfolio's purchase price upon
exercise may be greater than the price at which the securities might be
purchased in the securities market.
While the holder or writer of an option on a futures contract may
normally terminate its position by selling or purchasing an offsetting option of
the same series, a Proprietary Portfolio's ability to establish and close out
options positions at fairly established prices will be subject to the
maintenance of a liquid market. A Proprietary Portfolio will not purchase or
write options on futures contracts unless the market for such options has
sufficient liquidity such that the risks associated with such options
transactions are not at unacceptable levels.
LIMITATIONS ON PURCHASE AND SALE OF FUTURES CONTRACTS AND OPTIONS ON
FUTURES CONTRACTS. In general, certain of the Proprietary Portfolios will engage
in transactions in futures contracts and related options only for bona fide
hedging and other appropriate risk management purposes, and not for speculation.
The Proprietary Portfolios will not enter into futures contracts for which the
aggregate contract amounts exceed 100% of the Proprietary Portfolio's net
assets. In addition, with respect to positions in futures and related options
that do not constitute bona fide hedging positions, a Proprietary Portfolio will
not enter into a futures contract or futures option contract if, immediately
thereafter, the aggregate initial margin deposits relating to such positions
plus premiums paid by it for open futures option positions, less the amount by
which any such options are "in-the-money," would exceed 5% of the Proprietary
Portfolio's total assets. A call option is "in-the-money" if the value of the
futures contract that is the subject of the option exceeds the exercise price. A
put option is "in-the-money" if the exercise price exceeds the value of the
futures contract that is the subject of the option. Each Proprietary Portfolio
intends to limit its investment in options to one-third of its total assets.
When purchasing a futures contract, a Proprietary Portfolio will
maintain with its custodian (and mark-to-market on a daily basis) cash, U.S.
Government securities, or other high quality liquid debt securities that, when
added to the amounts deposited with a futures commission merchant as margin, are
equal to the market value of the futures contract. Alternatively, the
Proprietary Portfolio may "cover" its position by purchasing a put option on the
same futures contract with a strike price as high or higher than the price of
the contract held by the Proprietary Portfolio.
When selling a futures contract, a Proprietary Portfolio will maintain
with its custodian (and mark-to-market on a daily basis) liquid assets that,
when added to the amount deposited with a futures commission merchant as margin,
are equal to the market value of the instruments underlying the contract.
Alternatively, a Proprietary Portfolio may "cover" its position by owning the
instruments underlying the contract (or, in the case of an index futures
contract, a portfolio with a volatility substantially similar to that of the
index on which the futures contract is based), or by holding a call option
permitting the Proprietary Portfolio to purchase the same futures contract
20
<PAGE> 62
at a price no higher than the price of the contract written by the Proprietary
Portfolio (or at a higher price if the difference is maintained in liquid assets
with the Proprietary Portfolio's custodian).
When selling a call option on a futures contract, a Proprietary
Portfolio will maintain with its custodian (and mark-to-market on a daily basis)
cash, U.S. Government securities, or other high quality liquid debt securities
that, when added to the amounts deposited with a futures commission merchant as
margin, equal the total market value of the futures contract underlying the call
option. Alternatively, a Proprietary Portfolio may cover its position by
entering into a long position in the same futures contract at a price no higher
than the strike price of the call option, by owning the instruments underlying
the futures contract, or by holding a separate call option permitting the
Proprietary Portfolio to purchase the same futures contract at a price not
higher than the strike price of the call option sold by the Proprietary
Portfolio.
When selling a put option on a futures contract, a Proprietary
Portfolio will maintain with its custodian (and mark-to-market on a daily basis)
cash, U.S. Government securities, or other high quality liquid debt securities
that equal the purchase price of the futures contract, less any margin on
deposit. Alternatively, a Proprietary Portfolio may cover the position either by
entering into a short position in the same futures contract, or by owning a
separate put option permitting it to sell the same futures contract so long as
the strike price of the purchased put option is the same or higher than the
strike price of the put option sold by the Proprietary Portfolio.
The requirements for qualification as a regulated investment company
also may limit the extent to which a Proprietary Portfolio may enter into
futures or futures options. See "Federal Income Taxes."
RISKS ASSOCIATED WITH FUTURES AND FUTURES OPTIONS. There are several
risks associated with the use of futures contracts and futures options as
hedging techniques. A purchase or sale of a futures contract may result in
losses in excess of the amount invested in the futures contract. There can be no
guarantee that there will be a correlation between price movements in the
hedging vehicle and in the Proprietary Portfolio's securities being hedged. In
addition, there are significant differences between the securities and futures
markets that could result in an imperfect correlation between the markets,
causing a given hedge not to achieve its objectives. The degree of imperfection
of correlation depends on circumstances such as variations in speculative market
demand for futures and futures options on securities, including technical
influences in futures trading and futures options, and differences between the
financial instruments being hedged and the instruments underlying the standard
contracts available for trading in such respects as interest rate levels,
maturities, and creditworthiness of issuers. A decision as to whether, when and
how to hedge involves the exercise of skill and judgment, and even a
well-conceived hedge may be unsuccessful to some degree because of market
behavior or unexpected interest rate trends.
Futures exchanges may limit the amount of fluctuation permitted in
certain futures contract prices during a single trading day. The daily limit
establishes the maximum amount that the price of a futures contract may vary
either up or down from the previous day's settlement price at the end of the
current trading session. Once the daily limit has been reached in a futures
21
<PAGE> 63
contract subject to the limit, no more trades may be made on that day at a price
beyond that limit. The daily limit governs only price movements during a
particular trading day and therefore does not limit potential losses because the
limit may work to prevent the liquidation of unfavorable positions. For example,
futures prices have occasionally moved to the daily limit for several
consecutive trading days with little or no trading, thereby preventing prompt
liquidation of positions and subjecting some holders of futures contracts to
substantial losses.
There can be no assurance that a liquid market will exist at the time
when a Proprietary Portfolio seeks to close out a futures or futures option
position, and that Proprietary Portfolio would remain obligated to meet margin
requirements until the position is closed. In addition, many of the contracts
discussed above are relatively new instruments without a significant trading
history. As a result, there can be no assurance that an active secondary market
will develop or continue to exist.
ADDITIONAL RISKS OF OPTIONS ON SECURITIES, FUTURES CONTRACTS, OPTIONS
ON FUTURES CONTRACTS, AND FORWARD CURRENCY EXCHANGE CONTRACTS AND OPTIONS
THEREON. Options on securities, futures contracts, options on futures contracts,
currencies and options on currencies may be traded on foreign exchanges. Such
transactions may not be regulated as effectively as similar transactions in the
United States; may not involve a clearing mechanism and related guarantees; and
are subject to the risk of governmental actions affecting trading in, or the
prices of, foreign securities. The value of such positions also could be
adversely affected by (i) other complex foreign political, legal and economic
factors, (ii) lesser availability than in the United States of data on which to
make trading decisions, (iii) delays in a Proprietary Portfolio's ability to act
upon economic events occurring in foreign markets during non-business hours in
the United States, (iv) the imposition of different exercise and settlement
terms and procedures and margin requirements than in the United States, and (v)
lesser trading volume.
SWAP AGREEMENTS. Certain of the Proprietary Portfolios may enter into
index and currency exchange rate swap agreements for purposes of attempting to
obtain a particular desired return at a lower cost to the Proprietary Portfolio
than if the Proprietary Portfolio had invested directly in an instrument that
yielded that desired return or for other portfolio management purposes. Swap
agreements are two party contracts entered into primarily by institutional
investors for periods ranging from a few weeks to more than one year. In a
standard "swap" transaction, two parties agree to exchange the returns (or
differentials in rates of return) earned or realized on particular predetermined
investments or instruments. The gross returns to be exchanged or "swapped"
between the parties are calculated with respect to a "notional amount," i.e.,
the return on or increase in value of a particular dollar amount invested in a
particular foreign currency or in a "basket" of securities representing a
particular index. The "notional amount" of the swap agreement is only a fictive
basis on which to calculate the obligations which the parties to a swap
agreement have agreed to exchange. A Proprietary Portfolio's obligations (or
rights) under a swap agreement will generally be equal only to the net amount to
be paid or received under the agreement based on the relative values of the
positions held by each party to the agreement (the "net amount"). A Proprietary
Portfolio's obligations under a swap agreement will be accrued daily (offset
against any amounts owing to the Proprietary Portfolio) and any accrued but
unpaid net amounts owed to a swap counterparty will be covered by the
maintenance of a
22
<PAGE> 64
segregated account consisting of cash, U.S. Government securities, or high grade
debt obligations, to avoid any potential leveraging of the Proprietary
Portfolio's portfolio. Certain of the Proprietary Portfolios may enter into swap
agreements only to the extent that obligations under such agreements represent
not more than 10% of the Proprietary Portfolio's total assets.
Whether a Proprietary Portfolio's use of swap agreements will be
successful in furthering its investment objective will depend on the Adviser's
ability to predict correctly whether certain markets are likely to produce
greater returns than other markets. Because they are two party contracts and
because they may have terms of greater than seven days, swap agreements may be
considered to be illiquid. Moreover, the Proprietary Portfolio bears the risk of
loss of the amount expected to be received under a swap agreement in the event
of the default or bankruptcy of a swap agreement counterparty. The adviser to
some of the Proprietary Portfolios may enter into swap agreements only with
counterparties that would be eligible for consideration as repurchase agreement
counterparties under the Proprietary Portfolio's repurchase agreement
guidelines. Certain restrictions imposed on the Proprietary Portfolio by the
Internal Revenue Code may limit the Proprietary Portfolio's ability to use swap
agreements. The swaps market is a relatively new market and is largely
unregulated. It is possible that developments in the swaps market, including
potential government regulation, could adversely affect the Proprietary
Portfolio's ability to terminate existing swap agreements or to realize amounts
to be received under such agreements.
Certain swap agreements are exempt from most provisions of the
Commodity Exchange Act ("CEA") and, therefore, are not regulated as futures or
commodity option transactions under the CEA, pursuant to regulations approved by
the CFTC. To qualify for this exemption, a swap agreement must be entered into
by "eligible participants," which includes the following, provided the
participants' total assets exceed established levels: a bank or trust company,
savings association or credit union, insurance company, investment company
subject to regulation under the Investment Company Act of 1940, commodity pool,
corporation, partnership, proprietorship, organization, trust or other entity,
employee benefit plan, governmental entity, broker-dealer, futures commission
merchant, natural person, or regulated foreign person. To be eligible, natural
persons and most other entities must have total assets exceeding $10 million;
commodity pools and employee benefit plans must have total assets exceeding $5
million. An eligible swap transaction must also meet three conditions. First,
the swap agreement may not be part of a fungible class of agreements that are
standardized as to their material economic terms. Second, the creditworthiness
of parties with actual or potential obligations under the swap agreement must be
a material consideration in entering into or determining the terms of the swap
agreement, including pricing, cost or credit enhancement terms. Third, swap
agreements may not be entered into and traded on or through a multilateral
transaction execution facility.
This exemption is not exclusive, and participants may continue to rely
on existing exclusions for swaps, such as the Policy Statement issued in July
1989 which recognized a safe harbor for swap transactions from regulation as
futures or commodity option transactions under the CEA or its regulations. The
Policy Statement applies to swap transactions settled in cash that (1) have
individually tailored terms, (2) lack exchange style offset and the use of a
clearing organization or margin system, (3) are undertaken in conjunction with a
line of business, and (4) are not marketed to the public.
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<PAGE> 65
SECURITIES OF OTHER INVESTMENT COMPANIES. Certain of the Proprietary
Portfolios may invest up to 5% of its total assets in the securities of any one
investment company, but [COLLECTIVELY] may not own more than 3% of the total
outstanding securities of any one investment company or invest more than 10% of
its total assets in the securities of other investment companies. Pursuant to an
exemptive order issued by the Securities and Exchange Commission (the "SEC" or
the "Commission"), certain of the Proprietary Portfolios may invest in the money
market funds of other investment companies advised by KMFA or its affiliates.
The adviser to a Proprietary Portfolio will waive its fee with respect to assets
of the Proprietary Portfolio invested in a money market fund that it or its
affiliate advises, and, to the extent required by the laws of any state in which
a Proprietary Portfolio's shares are sold, the adviser to the Proprietary
Portfolio will waive its investment advisory fee as to all assets invested in
other investment companies. Because such other investment companies employ an
investment adviser, such investment by a Proprietary Portfolio will cause
shareholders to bear duplicative fees, such as management fees, to the extent
advisory fees are not waived by the Adviser to the Proprietary Portfolio.
REPURCHASE AGREEMENTS. Securities held by certain of the Proprietary
Portfolios may be subject to repurchase agreements. Under the terms of a
repurchase agreement, a Proprietary Portfolio would acquire securities from
financial institutions or registered broker-dealers deemed creditworthy by its
Adviser pursuant to guidelines adopted by the Directors of the Company, subject
to the seller's agreement to repurchase such securities at a mutually
agreed-upon date and price. The seller is required to maintain the value of
collateral held pursuant to the agreement at not less than the repurchase price
(including accrued interest). If the seller were to default on the repurchase
obligation or become insolvent, the Proprietary Portfolio holding such
obligation would suffer a loss to the extent that the proceeds from a sale of
the underlying portfolio securities were less than the repurchase price, or to
the extent that the disposition of such securities by the Proprietary Portfolio
is delayed pending court action.
REVERSE REPURCHASE AGREEMENTS. Certain of the Proprietary Portfolios
may borrow funds for temporary purposes by entering into reverse repurchase
agreements in accordance with the investment restrictions described below.
Pursuant to such agreements, a Proprietary Portfolio would sell portfolio
securities to financial institutions such as banks and broker-dealers, and agree
to repurchase them at a mutually agreed-upon date and price. At the time a
Proprietary Portfolio enters into a reverse repurchase agreement, it will place
in a segregated custodial account assets (such as cash or other liquid
high-grade securities) consistent with such Proprietary Portfolio's investment
restrictions having a value equal to the repurchase price (including accrued
interest); the collateral will be marked-to-market on a daily basis, and will be
continuously monitored to ensure that such equivalent value is maintained.
Reverse repurchase agreements involve the risk that the market value of the
securities sold by a Proprietary Portfolio may decline below the price at which
the Proprietary Portfolio is obligated to repurchase the securities.
"WHEN-ISSUED" SECURITIES. Certain of the Proprietary Portfolios may
purchase securities on a "when-issued" basis (i.e., for delivery beyond the
normal settlement date at a stated price and yield). The payment obligation and
interest rate that will be received on when-issued securities
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<PAGE> 66
are fixed at the time the buyer enters into the commitment. When a Proprietary
Portfolio agrees to purchase securities on a "when-issued" basis, the
Proprietary Portfolio's 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 the
purchase commitment, and in such a case, a Proprietary Portfolio may be required
subsequently to place additional assets in the separate account in order to
assure that the value of the account remains equal to the amount of the
Proprietary Portfolio's commitment. It may be expected that any such Proprietary
Portfolio's net assets will fluctuate to a greater degree when it sets aside
portfolio securities to cover such purchase commitments than when it sets aside
cash. To the extent cash is set aside in a separate account, it will not be
available for new investment or to meet redemptions.
When a Proprietary Portfolio engages in "when-issued" transactions, it
relies on the seller to consummate the trade. Failure of the seller to do so may
result in the Proprietary Portfolio incurring a loss or missing the opportunity
to obtain a price considered to be advantageous.
The investment policies of the Proprietary Portfolios set forth above
may be changed or altered by the Board of Directors of the Proprietary
Portfolios, except to the extent they are stated to be fundamental.
Furthermore, some or all of the investment practices described above
may be followed by the Other Portfolios in which the Funds may invest. The Funds
have no control over the investment activities of the Other Portfolios. There
may, in fact, be additional investment practices and underlying risks, not
discussed herein, that both the Proprietary Portfolios and Other Portfolios
may engage in from time to time (e.g., investing in collateralized mortgage
obligations).
INVESTMENT RESTRICTIONS OF THE FUNDS
The following investment restrictions are fundamental policies of each
of the Funds and may only be changed if approved by the holders of a majority of
the outstanding voting securities of the affected Fund. Under the Investment
Company Act of 1940, as amended ("1940 Act") such approval requires the
affirmative vote, at a meeting of shareholders of a Fund, of (i) at least 67% of
the shares of the Fund present at the meeting, if the holders of more than 50%
of the outstanding shares of the Fund are present in person or by represented
proxy; or (ii) more than 50% of the outstanding shares of the Fund, whichever is
less.
The Funds may not:
1. Make investments for the purpose of exercising control or
management (but this shall not prevent a Fund from purchasing a
controlling interest in one or more Underlying Portfolios
consistent with its investment objectives and policies).
2. Purchase or sell physical commodities or commodities contracts
(but this shall not prevent a Fund from investing in Underlying
Portfolios that purchase or sell options and futures contracts,
or from investing in securities or other instruments backed by
physical commodities).
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<PAGE> 67
3. Purchase or sell real estate (but this shall not prevent a Fund
from investing in Underlying Portfolios that invest in marketable
securities or other instruments backed by real estate or
securities of companies engaged in the real estate business).
4. Issue any senior security (as defined in the 1940 Act), except
that (a) a Fund may invest in Underlying Portfolios that engage
in transactions that may result in the issuance of senior
securities to the extent permitted under applicable regulations
and interpretations of the 1940 Act or an exemptive order; (b) a
Fund may invest in Underlying Portfolios that may acquire other
securities, the acquisition of which may result in the issuance
of a senior security, to the extent permitted under applicable
regulations or interpretations of the 1940 Act; and (c) subject
to the restrictions set forth below, a Fund may borrow money as
authorized by the 1940 Act.
5. Borrow money, except that (a) a Fund may invest in Underlying
Portfolios that enter into commitments to purchase mutual fund
shares or securities in accordance with its investment program,
including delayed-delivery and when-issued securities and reverse
repurchase agreements, provided that the total amount of any such
borrowing does not exceed one-third of the Fund's total assets;
and (b) a Fund may invest in Underlying Portfolios that borrow
money from banks for temporary or emergency purposes, including
meeting redemption requests, in an amount not exceeding 5% of the
lower of market value or the cost of its total assets at the time
when the loan is made, in which case it may pledge, mortgage or
hypothecate any of its assets as security for such borrowing, but
not to an extent greater than 5% of the market value of its
assets.
6. Lend any security or make any other loan, except that a Fund may
invest in Underlying Portfolios that purchase portfolio
securities consistent with their investment objectives and
policies, and lend less than one-third of their total assets but
this limitation does not apply to purchases of publicly issued
debt securities or to repurchase agreements.
7. Underwrite securities issued by others, except to the extent that
a Fund (or an Underlying Portfolio) may be deemed an underwriter
within the meaning of the Securities Act of 1933 in the
disposition of portfolio securities.
8. Invest directly in oil, gas or other mineral exploration or
development programs; provided that the Underlying Portfolios in
which the Funds invest may purchase the securities of the
companies engaged in such activities.
The following investment restrictions are non-fundamental and may be
changed without a vote of the shareholders of a Fund:
1. A Fund will not purchase or retain securities of any issuer
(other than the Proprietary Portfolios) if the officers or
Directors of the Company or the officers or directors of
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the investment adviser to the Fund owning directly or
beneficially more than one half of 1% of the securities of such
issuer together own directly or beneficially more than 5% of such
securities.
2. A Fund will not invest more than 5% of its total assets in the
securities of issuers which, together with any predecessors, have
a record of less than three years of continuous operation (except
for the Proprietary Portfolios), but a Fund may invest in
Underlying Portfolios that do so invest.
3. A Fund will not invest in illiquid securities (but this does not
preclude a Fund from investing in Underlying Portfolios which
invest in illiquid securities in an amount of less than 15% of
its net assets). An illiquid security is a security which cannot
be disposed of promptly (within seven days), and in the usual
course of business at approximately the price at which the Fund
has valued them. Such securities include, but are not limited to,
time deposits and repurchase agreements with maturities longer
than seven days. Securities that may be resold under Rule 144A
and securities acquired in a transaction or chain of transactions
pursuant to Section 4(2) of, or securities otherwise subject to
restrictions or limitations on resale, under the 1933 Act
("Restricted Securities"), shall not be deemed illiquid solely by
reason of being unregistered.
4. A Fund will not make short sales of securities, other than short
sales "against the box," except for short-term credits necessary
for clearance of portfolio transactions, provided that this
restriction will not be applied to limit the use of options,
futures contracts and related options, in the manner otherwise
permitted by the investment restrictions, policies and investment
program of the Fund.
5. As a non-fundamental operating policy a Fund may not purchase
securities on margin except for short-term credits necessary for
clearance of portfolio transactions, and neither may a Fund
invest in Underlying Portfolios that purchase securities on
margin.
6. A Fund will not participate on a joint, or a joint and several,
basis in any trading account in securities, except pursuant to a
SEC exemptive order or otherwise permitted by the 1940 Act; the
"bunching" of orders for the sale or purchase of portfolio
securities with other funds advised by the Adviser or its
affiliates to reduce brokerage commissions or otherwise to
achieve best overall execution is not considered participation in
a trading account in securities.
The policies and limitations listed above supplement those set forth in
the Prospectus. Unless otherwise noted, whenever an investment policy or
limitation states a maximum percentage of a Fund's net assets that may be
invested in any security or other asset, or sets forth a policy regarding
quality standards, such standard or percentage limitation will be determined
immediately after and as a result of the Fund's acquisition of such security or
other asset except in the case of borrowing (or other activities that may be
deemed to result in the issuance of a "senior
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<PAGE> 69
security" under the 1940 Act). Accordingly, any subsequent change in values, net
assets, or other circumstances will not be considered when determining whether
the investment complies with the Fund's investment policies and limitations.
The Funds may make commitments more restrictive than the foregoing
restrictions in order to permit the sale of Fund shares in certain states. Such
commitments are terminable at the discretion of the Company by terminating the
sale of shares of the Fund in the relevant state.
Notwithstanding the foregoing restrictions, the Proprietary Portfolios
and Other Portfolios in which the Fund may invest have adopted certain
investment restrictions which may be more or less restrictive than those listed
above, thereby allowing a Fund to participate in certain investment strategies
indirectly that are prohibited under the fundamental and non-fundamental
investment restrictions listed above. The investment restrictions of these
Underlying Portfolios are set forth in their respective statements of additional
information.
PORTFOLIO TURNOVER
Purchases and sales of securities are made at such times as the Adviser
deems to be in the best interest of the Funds' shareholders without regard to
the rate of portfolio turnover, about which there are no restrictions. A Fund
may purchase or sell shares of the Underlying Portfolios or other securities to:
(a) accommodate purchases and sales of its shares, (b) change the percentage of
its assets invested in each of the Underlying Portfolios in response to market
conditions, and (c) reallocate and rebalance its assets among the equity, bond
and fixed-income securities, money market funds, and cash, and among these
Underlying Portfolios within the percentage limits set forth in the Prospectus.
From time to time, the Funds may trade in securities for the short term. It is
anticipated that the annual portfolio turnover rate of the Growth Fund,
Moderate Growth Fund and the Conservative Growth Fund will not exceed __%, __%
and __%, respectively. In any particular year, market conditions could result
in portfolio activity at a greater or lesser rate than anticipated. Portfolio
turnover rate is, generally, the percentage computed by dividing the lesser of
purchases or sales by the average daily net assets of the portfolio for the
time period. High portfolio turnover involves correspondingly higher brokerage
commission expenses which are borne directly by the Funds. In addition, the
effect of engaging in options transactions may be to increase portfolio
turnover.
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<PAGE> 70
MANAGEMENT OF THE FUNDS
DIRECTORS AND OFFICERS
CONFLICTS OF INTEREST
The Directors and Officers of KMF are subject to conflicts of interest
in managing both the Funds described here and some of the underlying Proprietary
Portfolios. This conflict is most evident in the Board's supervision of the
Investment Adviser. The Adviser and certain of its affiliates may provide
services to, and receive fees from, not just the Funds, but also some of the
Proprietary and Other Portfolios. Their selection of investments and allocation
of Fund assets will be continuously and closely scrutinized by the Board in
order to avoid even the appearance of improper practices. It is possible,
however, that a situation might arise where one course of action for a Fund
would be detrimental to a Proprietary Portfolio, or vice versa. In that unlikely
event, the Directors and Officers of the Funds will exercise good business
judgment in upholding their fiduciary duties to each set of funds. Thus, such
conflicts, if any, can be minimized.
Officers and employees of the Adviser are not permitted to serve as
officers or directors of the Funds due to certain regulatory restrictions
imposed on banking organizations and their subsidiaries. See "Investment Adviser
and Administrator" below. The persons who have been elected to serve as officers
and directors of the Funds, their position with the Funds and their principal
occupations during the last five years are set forth below:
<TABLE>
<CAPTION>
NAME, AGE, ADDRESS AND PRINCIPAL
OCCUPATION DURING PAST FIVE YEARS POSITION WITH REGISTRANT
- --------------------------------- ------------------------
<S> <C>
EDWARD P. CAMPBELL (46) 28601 Clemens Road, Westlake, Director
Ohio 44145. Executive Vice President and Chief
Operating Officer of Nordson Corporation (manufacturer
of application equipment). Currently, Trustee of The
Victory Portfolios mutual fund complex.
EUGENE J. MCDONALD (62) 2200 Main Street, Suite 1000, Director
Durham, North Carolina 27705. Executive Vice President
for Asset Management of Duke University and President
of Duke Management Co.; Director of Central Carolina
Financial Corp. and Sphinx Pharmaceuticals, Inc.
FRANK A. WEIL (64) 147 E. 48th Street, New York, Non-Executive
New York 10017. Chairman and Chief Executive Officer Chairman and
of Abacus & Associates, Inc. (private investment firm). and Director
Chairman of the Council for Excellence in Government and Director and
President of the Norman and Hickrill Foundations.
</TABLE>
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<PAGE> 71
<TABLE>
<S> <C>
*LEIGH A. WILSON (51) 53 Sylvan Road N., Westport, CT 06880. From 1989 to President
present, Chairman and Chief Executive Officer of Glenleigh International and Director
President Limited (merchant bank); from 1993 to present, President of The
Victory Funds. Currently, Principal of New Century Living, Inc.; Director
of and Director Chimney Rock Vineyard & Chimney Rock Winery; and Trustee of
The Victory Portfolios mutual fund complex. Previously, Chief Executive
Officer, Paribas North America and Paribas Corporation.
WILLIAM B. BLUNDIN (57) 125 West 55th Street, New York, Vice President
NY 10019. Vice Chairman of Concord Holding Corp.
SCOTT A. ENGLEHART (33) 3435 Stelzer Road, Columbus, Vice President and
Ohio 43219. Director of Client Services, BISYS Fund Assistant Secretary
Services, Inc. (October 1990 to present).
KEVIN L. MARTIN (35) 3435 Stelzer Road, Columbus, Ohio Treasurer
43219. Vice President of Accounting Services, BISYS
Fund Services, Inc. (February 1996 to present); Senior
Manager at Ernst & Young (1984 to February 1996)
KAREN A. DOYLE (38) 125 West 55th Street, New York, NY 10019. Secretary
Manager of Client Services, BISYS Fund Services, Inc.,
(October 1994 to present); Assistant Treasurer at The Bank of New York (April
1979 to October 1994).
ROBERT L. TUCH (44) 3435 Stelzer Road, Columbus, Ohio 43219. Assistant Secretary
Employee of BISYS Fund Services, Inc. (June 1991 to
present); Vice President and Associate General Counsel,
National Securities Research Corp. (July 1990 to June 1991).
ALAINA V. METZ (29) 3435 Stelzer Road, Columbus, Ohio Assistant Secretary
43219. Chief Administrator, Administrative and
Regulatory Services, BISYS Fund Services Limited
Partnership (June 1995 to present); Supervisor, Mutual
Fund Legal Department, Alliance Capital Management
(May 1989 to June 1995).
</TABLE>
* Mr. Wilson is an "interested person" of the Company solely by reason of his
position as President.
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<PAGE> 72
Directors who are not "interested persons" of either an investment
adviser to or principal underwriter for KMF receive an annual fee of $7,500 plus
$750 per meeting of the Board of Directors attended and reasonable out-of-pocket
expenses incurred in connection with attending such meetings. Each director who
is an "interested person" of either an investment adviser to or principal
underwriter for KMF does not receive any compensation from the Company.
<TABLE>
<CAPTION>
AGGREGATE COMPENSATION TOTAL COMPENSATION
FROM COMPANY FOR FROM COMPANY
THE FISCAL YEAR ENDED AND VICTORY FUND
NAME NOVEMBER 30, 1995 COMPLEX
- ---- ---------------------- ------------------
<S> <C> <C>
Edward P. Campbell $6,000 $33,800(2)
Ted H. McCourtney $9,375 $ 9,375(1)(3)
Eugene J. McDonald $9,375 $ 9,375(3)
Frank A. Weil $9,375 $ 9,375(3)
Leigh A. Wilson $6,000 $46,717(2)
</TABLE>
(1) Mr. McCourtney resigned his position as a Director of the Company
effective December 7, 1995.
(2) These amounts include compensation received from the Company, The
Victory Funds (which were reorganized into The Victory Portfolios as of
June 5, 1995), and Collective Investment Retirement Funds of Society
National Bank, which were reorganized into the Victory Balanced Fund
and Victory Government Mortgage Fund as of December 17, 1994. There are
presently 24 operating portfolios in the Victory "Fund Complex" from
which Messrs. Campbell and Wilson receive compensation.
(3) Total compensation paid with respect to service on the Board of
Directors of the Company only.
MANAGEMENT OF THE PROPRIETARY PORTFOLIOS
The Funds are shareholders in the Proprietary Portfolios. A brief description of
the management of KMF and VP is set forth below.
KEY MUTUAL FUNDS' DIRECTORS AND OFFICERS:
The persons who have been elected to serve as officers and directors of
KMF, their position with KMF and their principal occupations during the last
five years are identical to the information listed immediately above for the
Funds.
VICTORY PORTFOLIOS' BOARD OF TRUSTEES:
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<PAGE> 73
Overall responsibility for management of the Victory Portfolios rests
with the Trustees, who are elected by the shareholders of the Victory
Portfolios. The Victory Portfolios are managed by the Trustees in accordance
with the laws of the State of Delaware governing business trusts. There are
currently seven Trustees, six of whom are not "interested persons" of the
Victory Portfolios within the meaning of that term under the 1940 Act
("Independent Trustees"). The Trustees, in turn, elect the officers of the
Victory Portfolios to actively supervise its day-to-day operations.
The Trustees of the Victory Portfolios, their addresses, ages and their
principal occupations during the past five years are as follows:
<TABLE>
<CAPTION>
NAME, AGE, ADDRESS AND PRINCIPAL POSITION(S) HELD WITH
OCCUPATION DURING PAST FIVE YEARS THE VICTORY PORTFOLIOS
- --------------------------------- ----------------------
<S> <C>
LEIGH A. WILSON* (51) 53 Sylvan Road N., Westport, CT 06880. From 1989 to Trustee and
present, Chairman and Chief Executive Officer of Glenleigh International Limited President
Trustee and (merchant bank); from 1993 to present, President of The Victory
Funds. Currently, Principal of New Century Living, Inc.; Director of Chimney
Rock Vineyard & President Chimney Rock Winery; and Trustee of The Victory
Portfolios mutual fund complex. Previously, Chief Executive Officer, Paribas
North America and Paribas Corporation.
ROBERT G. BROWN (72) 5460 N. Ocean Drive, Singer Island, Riviera Beach, FL Trustee
33404. Retired; from October 1983 to November 1990, President Cleveland Advanced
Manufacturing Program (non-profit corporation engaged in regional economic
development).
EDWARD P. CAMPBELL (46) Nordson Corporation, 28601 Clemens Road, Westlake, OH Trustee
44145. From March 1994 to present, Executive Vice President and Chief Operating
Officer of Nordson Corporation (manufacturer of application equipment); from May
1988 to March 1994, Vice President of Nordson Corporation; from 1987 to December
1994, member of the Supervisory Committee of Society's Collective Investment
Retirement Fund; from May 1991 to August 1994, Trustee, Financial Reserves Fund
and from May 1993 to August 1994, Trustee, Ohio Municipal Money Market Fund;
Trustee, The Victory Funds and the SBSF Funds, Inc., dba Key Mutual Funds.
</TABLE>
32
<PAGE> 74
<TABLE>
<S> <C>
DR. HARRY GAZELLE (68) 17822 Lake Road, Lakewood, Ohio 44107. Retired Trustee
radiologist, Drs. Hill and Thomas Corp.; Trustee, the Victory Funds
STANLEY I. LANDGRAF (70) 41 Traditional Lane, Loudonville, NY 12211. Retired; Trustee
currently, Trustee, Rensselaer Polytechnic Institute; Director, Elenel
Corporation and Mechanical Technology, Inc.; Member, Board of Overseers, School
of Management, Rensselaer Polytechnic Institute; Member, The Fifty Group (a
Capital Region business organization); Trustee, The Victory Funds.
DR. THOMAS F. MORRISSEY (63) Weatherhead School of Management, Case Western Trustee
Reserve University, 1900 Euclid Avenue, Cleveland, OH 44106-7234. 1995 Visiting
Scholar, Bond University, Queensland, Australia; Professor, Weatherhead School
of Management, Case Western Reserve University; from 1989 to 1995, Associate
Dean of Weatherhead School of Management; from 1987 to December 1994, Member of
the Supervisory Committee of Society's Collective Investment Retirement Fund;
from May 1991 to August 1994, Trustee, Financial Reserves Fund and from May 1993
to August 1994, Trustee, Ohio Municipal Money Market Fund; Trustee, The Victory
Funds.
DR. H. PATRICK SWYGERT (53) Howard University, 2400 6th Street, N.W., Suite 320, Trustee
Washington, DC 20059. President, Howard University; formerly President, State
University of New York at Albany; formerly, Executive Vice President, Temple
University; Trustee, the Victory Funds.
</TABLE>
* Mr. Wilson is deemed to be an "interested person" of the Victory Portfolios
under the 1940 Act solely by reason of his position as President.
THE INVESTMENT ADVISER OF THE FUNDS
INVESTMENT ADVISER. The investment adviser of the Funds is Key Mutual
Fund Advisers, Inc. ("KMFA" or the "Adviser"). KMFA was organized as an Ohio
Corporation on July 27, 1995 and is registered with the SEC as an investment
adviser under the Investment Advisers Act of 1940, as amended. KMFA is a wholly
owned subsidiary of KeyCorp Asset Management Holdings, Inc., which is a wholly
owned subsidiary of KeyBank National Association ("KeyBank"). KeyBank is a
wholly owned subsidiary of KeyCorp, one of the largest financial services
holding companies in the United States. As of March 31, 1996, KMFA and its
affiliates manage approximately $66 billion in assets for numerous clients,
including large corporate and
33
<PAGE> 75
public retirement plans, Taft-Hartley plans, foundations and endowments and high
net worth individuals.
As of March 31, 1996, KeyCorp had an asset base of $65 billion, with
banking offices in 26 states from Maine to Alaska, and trust and investment
offices in 16 states. KeyCorp is the resulting entity of the 1994 merger of
Society Corporation, the bank holding company of which KeyBank National
Association, formerly Society National Bank, was a wholly-owned subsidiary, and
KeyCorp, the former bank holding company. KeyCorp's major business activities
include providing consumer, business and traditional banking and associated
financial services to consumer, business and commercial markets. KeyCorp's
non-bank subsidiaries include investment advisory, securities brokerage,
insurance, bank credit card processing and leasing companies. KeyBank is the
lead affiliate bank of KeyCorp. KeyCorp's principal offices are located at 127
Public Square, Cleveland, Ohio 44114.
Pursuant to the Investment Advisory Agreement between the Company, on
behalf of the Funds, and KMFA (the "Investment Advisory Agreement"), KMFA
furnishes a continuous investment program for the Funds', conducts investment
research, makes the day-to-day investment decisions for the Funds, executes the
purchase and sale orders for the portfolio transactions of the Funds and
generally manages and supervises the Funds' investments in accordance with the
stated policies of the Funds, subject to the general supervision of the Board of
Directors of the Funds.
KMFA continuously monitors the allocation of each Fund's investment in
Underlying Portfolios in three distinct investment categories according to
certain percentage ranges predetermined by the Directors as follows:
<TABLE>
<CAPTION>
Conservative
Growth Fund Moderate Growth Fund Growth Fund
----------- -------------------- -----------
<S> <C> <C> <C>
Equity Funds 70-90% 50-70% 30-50%
Bond/Fixed Income Funds 10-30% 30-50% 50-70%
Money Market Funds/Cash 0-15% 0-15% 0-15%
</TABLE>
KMFA rebalances and reallocates its investments across Underlying Portfolios as
market conditions warrant. All reallocations are expected to occur within the
above-described ranges.
The selection of the Proprietary Portfolios in which the Growth Fund,
Moderate Growth Fund and Conservative Growth Fund will invest, as well as the
percentage of assets which can be invested in each type of underlying mutual
fund, are not fundamental investment policies and can be changed without the
approval of a majority of the respective Fund's shareholders. Any changes to the
percentage ranges shown above for allocation across types of Underlying
Portfolios or for allocation in Proprietary Portfolios and Other Portfolios
requires the approval of the Company's Board of Directors. Investors desiring
more information on a Proprietary Portfolio listed above may call Key Mutual
Funds and Victory Portfolios at 800-539-3863 to request a prospectus, which is
available without charge. The selection of the Other Portfolios also is within
the Adviser's discretion.
34
<PAGE> 76
Changes in the value of the Underlying Portfolios may affect cash
income, if any, derived from these investments and will affect a Fund's net
asset value. Because each Fund invests primarily in other mutual funds, which
fluctuate in value, the Funds' shares will correspondingly fluctuate in value.
Although the Funds normally seek to remain substantially fully invested in the
Underlying Portfolios, a Fund may invest temporarily in certain short-term
obligations. Such obligations may be used to invest uncommitted cash balances or
to maintain liquidity to meet shareholder redemptions. A Fund also may borrow
money for temporary or emergency purposes.
As compensation for the services rendered and related expenses borne by
the Adviser under the Investment Advisory Agreement, the Funds pay the Adviser a
fee, computed daily and payable monthly, equal to .15% per annum of the Fund's
average daily net assets. The Adviser is obligated to reimburse the Funds in the
event expenses exceed certain prescribed limits (see "Expenses, Distributor and
Distribution Plan").
Unless sooner terminated, the Investment Advisory Agreement, provides
that it will continue in effect for an initial two-year term and, with respect
to each Fund, for consecutive one-year terms thereafter, provided that such
continuance is approved at least annually by the Board of Directors of the
Company or by a vote of a majority of the outstanding voting securities of a
Fund (as defined in the 1940 Act), and, in either case, by a majority of the
Directors who are not parties to the Investment Advisory Agreement or interested
persons (as defined in the 1940 Act) of any such party, by votes cast in person
at a meeting called for such purpose.
The Investment Advisory Agreement is terminable as to a Fund at any
time on 60 days' written notice without penalty by the Directors, by vote of a
majority of the outstanding voting securities of the Fund, or by KMFA. The
Investment Advisory Agreement also terminates automatically in the event of its
assignment, as defined in the 1940 Act.
The Investment Advisory Agreement provides that KMFA shall not be
liable for any error of judgment or mistake of law or for any loss suffered by a
Fund in connection with the performance of its services pursuant to the
Investment Advisory Agreement, except a loss resulting from a breach of
fiduciary duty with respect to the receipt of compensation for services or a
loss resulting from willful misfeasance, bad faith or gross negligence on the
part of KMFA in the performance of its duties, or from reckless disregard by it
of either duties or obligations thereunder.
The Investment Advisory Agreement also provides that KMFA may delegate
a portion of its responsibilities to a sub-adviser. In addition, the Investment
Advisory Agreement provides that KMFA may render services through its own
employees or through the employees of one or more affiliated companies that are
qualified to act as an investment adviser to the Funds and are under the common
control of KeyCorp as long as all such persons are functioning as part of an
organized group of persons that is managed by authorized officers of KMFA.
Due to certain regulatory restrictions on banking organizations and
their subsidiaries, employees of the Adviser are not permitted to serve as
officers or directors of the Company.
35
<PAGE> 77
THE INVESTMENT ADVISER FOR THE PROPRIETARY PORTFOLIOS
As a shareholder in the Proprietary Portfolios, the Funds will bear
their proportionate share of the investment advisory fees paid by those Funds.
Set forth below is a description of the investment advisory agreements for each
Proprietary Portfolio.
KEY MUTUAL FUNDS:
The investment adviser to the KMF Funds is Spears, Benzak, Salomon &
Farrell, Inc. ("Spears"), a New York corporation that is registered as an
investment adviser with the Securities and Exchange Commission. Spears is a
wholly owned subsidiary of KeyCorp Asset Management Holdings, Inc. ("KAMHI") and
is an indirect wholly owned subsidiary of KeyBank National Association
("KeyBank"), which is wholly owned subsidiary of KeyCorp, one of the largest
financial services holding companies in the United States. KeyCorp's principal
offices are located at 127 Public Square, Cleveland, Ohio 44114.
Spears was, at November 30, 1995, investment adviser for assets
aggregating in excess of $3.6 billion. In addition to the KMF Funds, Spear's
advisory clients include individuals, pension and profit-sharing trusts,
partnerships, endowments and foundations. Spear's principal offices are located
at 45 Rockefeller Plaza, New York, NY 10111.
Pursuant to an Investment Advisory Agreement, Spears furnishes a
continuous investment program for the KMF Funds, makes the day-to-day investment
decisions for the KMF Funds, executes the purchase and sale orders for the
portfolio transactions of the KMF Funds and generally manages the KMF Funds'
investments in accordance with the stated policies of the KMF Funds, subject to
the general supervision of the Board of Directors of the Company.
Pursuant to a Sub-Administration Agreement between Spears and Concord
Holding Corporation ("Concord"), Spears provides the KMF Funds with certain
sub-administrative and fund accounting services. For its services as
sub-administrator, Concord pays Spears an annual fee of $500,000.
The principal portfolio manager of the SBSF Fund is Louis R. Benzak.
Mr. Benzak is a Managing Director and Vice Chairman of Spears and has been the
principal portfolio manager of the SBSF Fund since its inception. Christopher C.
Grisanti serves as a co-portfolio manager of the SBSF Fund. Mr. Grisanti, a Vice
President, Analyst and Portfolio Manager of Spears, has been associated with
Spears since 1994. Prior to that time, Mr. Grisanti was an attorney with
Simpson, Thatcher & Bartlett. Mr. Grisanti has served as a portfolio manager of
the SBSF Fund since April 1996. Mr. Benzak, Richard A. Janus and James K.
Kaesberg serve as co-portfolio managers of the SBSF Convertible Securities Fund.
Mr. Benzak has served as a portfolio manager of the SBSF Convertible Securities
Fund since the Fund's inception. Mr. Janus, in addition to his position as a
Vice President of Spears, is Senior Managing Director and Chief Investment
Officer of Convertible Securities Investments for Society Asset Management, Inc.
("Society"), an affiliate of Spears and an indirect wholly owned subsidiary of
KeyCorp. Mr. Janus
36
<PAGE> 78
has held various positions with Society (including its predecessors) since 1977,
and has served as a co-portfolio manager of the SBSF Convertible Securities Fund
since April 1996. Mr. Kaesberg also is associated with Society and currently
holds the position of Vice President and Portfolio Manager -- Convertible
Securities. Mr. Kaesberg has been employed by Society (including its
predecessors) since 1985, and has held his position as a co-portfolio manager of
the SBSF Convertible Securities Fund since April 1996. Mr. Kaesberg is a Vice
President of Spears.
Charles G. Crane is the principal portfolio manager of the SBSF Capital
Growth Fund. Mr. Crane is a Managing Director of Spears and has been associated
with Spears since 1988. Mr. Crane has served as a portfolio manager of SBSF
Capital Growth Fund since the Fund's inception. Annette Longnon Geddes is a
co-portfolio manager of the SBSF Capital Growth Fund. Ms. Geddes, a Vice
President of Spears, has been associated with Spears, and has served as a
portfolio manager of the SBSF Capital Growth Fund, since April 1996. Ms. Geddes
served as a portfolio manager with Steinhardt Management Company during 1995
and, from 1987 to 1994, held the position of Managing Director with Trust
Company of the West.
Under the Investment Advisory Agreement, as compensation for the
services rendered and related expenses borne by Spears, the SBSF Fund, the SBSF
Convertible Securities Fund and the SBSF Capital Growth Fund each are obligated
to pay Spears a fee, computed daily and payable monthly, equal to 0.75% per
annum of each such KMF Fund's average daily net assets. This fee is higher than
that paid by most investment companies, although it is believed that this fee is
comparable to fees paid by other investment companies with investment objectives
comparable to each such KMF Fund. For the fiscal year ended November 30, 1995,
the SBSF Fund and the SBSF Convertible Securities Fund paid Spears fees at the
effective annual rate of 0.75% of each Fund's average daily net assets. In
addition, during the fiscal year ended November 30, 1995, the SBSF Capital
Growth Fund incurred advisory fees at the effective annual rate of 0.16% of the
Fund's average daily net assets. Spears voluntarily waived the advisory fee
incurred by the SBSF Capital Growth Fund during the period from December 1, 1994
through September 30, 1995. Spears is obligated to reimburse the KMF Funds in
the event any Fund's expenses exceed certain prescribed limits. See "Expenses
and Distribution Plan."
VICTORY PORTFOLIOS
KeyCorp Mutual Fund Advisers, Inc. ("KMFA") is the investment adviser
to the Victory Portfolios. KMFA directs the investment of the VP Funds' assets,
subject at all times to the supervision of the Victory Portfolios' Board of
Trustees. KMFA continually conducts investment research and supervision for the
Funds and is responsible for the purchase and sale of the VP investments.
KMFA was organized as an Ohio corporation on July 27, 1995 and is
registered as an investment adviser under the Investment Advisers Act of 1940,
as amended. It is a wholly owned subsidiary of KeyCorp Asset Management
Holdings, Inc., which is a wholly owned subsidiary of KeyBank National
Association, a wholly owned subsidiary of Key Corp. KMFA and its affiliates
managed approximately $66 billion, as of March 31, 1996, for numerous clients
including large
37
<PAGE> 79
corporate and public retirement plans, Taft-Hartley plans, foundations and
endowments, high net worth individuals and mutual funds.
KeyCorp, a financial services holding company, is headquartered at 127
Public Square, Cleveland, Ohio 44114. As of September 30, 1995, KeyCorp had an
asset base of $68 billion, with banking offices in 26 states from Maine to
Alaska, and trust and investment offices in 16 states. KeyCorp is the resulting
entity of the merger in 1994 of Society Corporation, the bank holding Company of
which KeyBank, now Society National Bank, was a wholly-owned subsidiary, and
KeyCorp, the former bank holding company. KeyCorp's major business activities
include providing traditional banking and associated financial services to
consumer, business and commercial markets. Its non-bank subsidiaries include
investment advisory, securities brokerage, insurance, bank credit card
processing, and leasing companies.
KeyBank is the lead affiliate bank of KeyCorp.
The following schedule lists the advisory fees for each VP mutual fund
that is advised by KMFA.
.50 OF 1% OF AVERAGE DAILY NET ASSETS
Victory Limited Term Income Fund (1)
Victory Financial Reserves Fund (1)
Victory Fund for Income
.65 OF 1% OF AVERAGE DAILY NET ASSETS
Victory Diversified Stock Fund (1)
.75 OF 1% OF AVERAGE DAILY NET ASSETS
Victory Investment Quality Bond Fund (1)
Victory Ohio Regional Stock Fund (1)
1% OF AVERAGE DAILY NET ASSETS
Victory Value Fund (1)
Victory Growth Fund (1)
Victory Special Value Fund (1)
Victory Special Growth Fund
1.10% OF AVERAGE DAILY NET ASSETS
Victory International Growth Fund (1)
(1) Society Asset Management, Inc. serves as sub-adviser to each of these
funds. For its services under the Investment Sub-Advisory Agreement,
KMFA pays the Sub-Adviser sub-advisory fees at rates (based on
an annual percentage of average daily net assets) which vary according
to the table set forth below, following these footnotes.
38
<PAGE> 80
The Investment Sub-advisory fees payable by KMFA to the
Sub-Adviser are as follows:
For the Victory Diversified Stock Fund, For the Victory International Growth
Growth Fund, and Value Fund: Fund, Ohio Regional Stock Fund and
Special Value Fund:
<TABLE>
<CAPTION>
Rate of Sub-Advisory Rate of Sub-Advisory
Net Assets Fee (1) Net Assets Fee (1)
<S> <C> <C> <C>
Up to $10,000,000 0.65% Up to $10,000,000 0.90%
Next $15,000,000 0.50% Next $15,000,000 0.70%
Next $25,000,000 0.40% Next $25,000,000 0.55%
Above $50,000,000 0.35% Above $50,000,000 0.45%
</TABLE>
For the Victory Investment Quality Bond For the Victory Financial Reserves
Fund and Limited Term Income Fund: Fund:
<TABLE>
<CAPTION>
Rate of Sub-Advisory Rate of Sub-Advisory
Net Assets Fee (1) Net Assets Fee (1)
<S> <C> <C> <C>
Up to $10,000,000 0.40% Up to $10,000,000 0.25%
Next $15,000,000 0.30% Next $15,000,000 0.20%
Next $25,000,000 0.25% Next $25,000,000 0.15%
Above $50,000,000 0.20% Above $50,000,000 0.125%
</TABLE>
(1) As a percentage of average daily net assets. Note, however, that the
Sub-Adviser shall have the right, but not the obligation, to
voluntarily waive any portion of the sub-advisory fee from time to
time. Any such voluntary waiver will be irrevocable and determined in
advance of rendering sub-investment advisory services by the
Sub-Adviser, and will be in writing.
ADMINISTRATOR
BISYS Fund Services (the "Administrator") serves as the Administrator
of the Funds pursuant to an administration agreement dated [ ], 1996 (the
"Administration Agreement"). The Administrator assists in supervising all
operations of each Fund (other than those performed by KMFA under the Investment
Advisory Agreement), subject to the supervision of the Board of Directors.
For the services rendered to the Funds and related expenses borne by
BISYS Fund Services as Administrator, each Fund pays BISYS Fund Services an
annual fee, computed daily and paid monthly, equal to 1.00% of the average daily
net assets of each Fund. The Administrator may periodically waive all or a
portion of its fee with respect to any Fund in order
39
<PAGE> 81
to increase the net income of one or more of the Funds of the Company available
for distribution to shareholders.
Unless sooner terminated, the Administration Agreement will continue in
effect as to the Funds for a period of one year, and, with respect to each Fund,
for consecutive one year terms thereafter, provided that such continuance is
ratified at least annually by the Directors of the Company or by a vote of a
majority of the outstanding shares of the respective Funds, and in either case
by a majority of the Directors who are not parties to the Administration
Agreement or interested persons (as defined in the 1940 Act) of any party to the
Administration Agreement, by votes cast in person at a meeting called for such
purpose.
The Administration Agreement provides that the Administrator shall not
be liable for any error of judgment or mistake of law or any loss suffered by
the Funds in connection with the matters to which the Administration Agreement
relates, except a loss resulting from willful misfeasance, bad faith or gross
negligence in the performance of its duties, or from the reckless disregard by
it of its obligations and duties thereunder.
Under the Administration Agreement, the Administrator assists in the
Fund's administration and operation, including providing statistical and
research data, clerical services, internal compliance and various other
administrative services, including among other responsibilities, forwarding
certain purchase and redemption requests to the Transfer Agent, participation in
the updating of the prospectus, coordinating the preparation, filing, printing
and dissemination of reports to shareholders, coordinating the preparation of
income tax returns, arranging for the maintenance of books and records and
providing office facilities necessary to carry out its duties thereunder. Under
the Administration Agreement, the Administrator may delegate all or any part of
its responsibilities thereunder.
As Administrator, the Administrator is obligated to reimburse the Funds
in the event the Funds' expenses exceed certain prescribed limits. (See
"Expenses, Distributor and Distribution Plan").
FUND ACCOUNTANT. BISYS Fund Services, Inc. ("BISYS") serves as a fund
accountant for each Fund pursuant to a fund accounting agreement with the
Company dated [ ], 1996 (the "Fund Accounting Agreement"). As fund
accountant, BISYS calculates the Funds' net asset value, the dividend and
capital gain distribution, if any, and the yield. [BISYS also provides a current
security position report, a summary report of transactions and pending
securities, a current cash position report, and maintains the general ledger
accounting records for each Fund.] Under the Fund Accounting Agreement, BISYS is
entitled to receive a fee from each Fund equal to an annual rate of [ %]
of each Fund's average daily net assets.
EXPENSES, DISTRIBUTOR AND DISTRIBUTION PLAN
Except as set forth above, and as set forth below, the Funds are
responsible for the payment of their expenses. Such expenses include the fees
payable to KMFA; any brokerage fees
40
<PAGE> 82
and commissions; taxes; interest; the cost of any liability insurance or
fidelity bonds; costs, expenses, or losses arising out of any liability of or
claim for damages or other relief asserted against the Funds for violation of
any law; legal and auditing fees and expenses; the fees and certain expenses of
the Funds' Custodian, Transfer Agent and Distributor; the fees of any trade
association of which the Funds are a member; the expenses of printing and
mailing reports and notices to the Funds' shareholders; filing fees for the
registration or qualification of Funds shares under Federal or state securities
laws; the fees and expenses involved in registering and maintaining registration
of the Funds and of its shares with the Securities and Exchange Commission; fees
of directors who are not "interested persons" of an investment adviser to or the
principal underwriter for the Funds; the costs of registering the Funds as a
broker or dealer; the costs of qualifying its shares under state securities
laws; the expenses of servicing shareholders and shareholder accounts not
otherwise incurred by the Adviser or the Administrator; and any extraordinary
expenses incurred by the Funds.
As a result of certain regulatory restrictions imposed on banking
organizations and their subsidiaries, the Company is not permitted to sell
shares of the Funds directly without an independent underwriter. Accordingly,
pursuant to a distribution agreement dated April 5, 1996 (the "Distribution
Agreement"), BISYS Fund Services (the "Distributor") was appointed to serve as
independent underwriter/distributor for the continuous offering of the shares of
the Company. Under the Distribution Agreement, the Distributor is obligated to
devote its best efforts to effect sales of shares of the Funds, but is not
required to sell any certain number of shares. In addition, under the
Distribution Agreement, the Distributor may enter into agreements with selected
dealers for the distribution of shares of the Funds.
If not earlier terminated, the Distribution Agreement will continue in
effect for successive terms of one year, provided that such continuance is
specifically approved at least annually (a) by a majority of those members of
the Board of Directors of the Company who are not parties to the Agreement or
"interested persons" of any such party (the "Disinterested Directors"), pursuant
to a vote cast in person at a meeting called for the purpose of voting on such
approval, and (b) by the Board of Directors of the Company or by vote of a
"majority of the outstanding voting securities" of each Fund. The Distribution
Agreement may be terminated by the Company at any time with respect to any Fund,
without the payment of any penalty, by vote of a majority of the Disinterested
Directors or by vote of a "majority of the outstanding voting securities" of
such Fund on 60 days' written notice to the Distributor, or by the Distributor
at any time, without the payment of any penalty, on 60 days' written notice to
the Fund. The Distribution Agreement will automatically terminate in the event
of its "assignment".
The Company has adopted a Distribution Plan (the "Distribution Plan")
for the Funds pursuant to Rule 12b-1 under the 1940 Act. No separate payments
are authorized to be made by the Funds under the Plan. Rather, the Plan provides
that to the extent that any portion of the fees payable under the Shareholder
Servicing Plan or any Shareholder Servicing Agreement (described below) is
deemed to be for services primarily intended to result in the sale of Fund
shares, such fees are deemed approved and may be paid pursuant to the Plan and
in accordance with Rule 12b-1.
41
<PAGE> 83
Rule 12b-1 requires that the Distribution Plan be approved by a vote of
at least a majority of the outstanding voting securities of the Fund and by a
majority of the Board of Directors, including those directors who are not
"interested persons" of the Funds (as defined in the 1940 Act) and who have no
direct or indirect financial interest in the Distribution Plan. The Distribution
Plan must be approved at least annually in the manner described in the foregoing
sentence and may be terminated at any time by a vote of a majority of the
outstanding voting securities of the Fund or a majority of those directors who
are not "interested persons" and who have no direct or indirect financial
interest in the Distribution Plan.
While the Distribution Plan is in effect, the selection and nomination
of directors who are not "interested persons" of the Company (as defined in the
1940 Act) is committed to the discretion of the directors who are not interested
persons of the Company.
If total expenses borne by a Fund in any fiscal year exceed expense
limitations imposed by applicable state securities regulations, KMFA or the
Administrator will waive their fees to the extent such excess expenses exceed
such expense limitation in proportion to their respective fees. As of the date
of this Statement of Additional Information, the most restrictive expense
limitation applicable to the Funds limits the aggregate annual expenses of each
Fund, including management and advisory fees but excluding interest, taxes,
brokerage commissions, and certain other expenses, to 2.5% of the first $30
million of average net assets, 2.0% of the next $70 million of average net
assets and 1.5% of remaining average net assets. Any expenses to be borne by
KMFA or the Administrator will be estimated daily and reconciled and paid on a
monthly basis. Fees imposed on customer accounts by KMFA, Key Trust Company of
Ohio, N.A. or its correspondents, affiliated banks and other non-bank affiliates
for cash management services are not fund expenses for purposes of such
limitation.
SHAREHOLDER SERVICING PLAN
The Company, on behalf of the Growth Fund, Moderate Growth Fund and
Conservative Growth Fund, has adopted a Shareholder Servicing Plan to provide
payments to shareholder servicing agents (including affiliates of the Adviser)
(each a "Shareholder Servicing Agent") that provide administrative support
services to customers who may from time to time beneficially own shares of a
Fund, which services may include: (i) aggregating and processing purchase and
redemption requests for shares from customers and promptly transmitting net
purchase and redemption orders to the distributor or transfer agent; (ii)
providing customers with a service that invests the assets of their accounts in
shares pursuant to specific or preauthorized instructions; (iii) processing
dividend and distribution payments on behalf of customers; (iv) providing
information periodically to customers showing their positions in shares; (v)
arranging for bank wires; (vi) responding to customer inquiries; (vii) providing
sub-accounting with respect to shares beneficially owned by customers or
providing the information to the Fund necessary for sub-accounting; (viii) if
required by law, forwarding shareholder communications from us (such as proxies,
shareholder reports, annual and semi-annual financial statements and dividend,
distribution and tax notices) to customers; (ix) forwarding to customers proxy
statements and proxies containing any proposals regarding this Plan; and (x)
providing such other similar services as reasonably requested to the extent the
Shareholder Servicing Agent is permitted to do so under applicable statutes,
rules or
42
<PAGE> 84
regulations. For expenses incurred and services provided pursuant to the
Shareholder Servicing Agreement, the Fund pays each Shareholder Servicing Agent
a fee computed daily and payable monthly, in amounts aggregating not more than
0.25% on an annual basis, of the average daily net assets of the Fund. A
Shareholder Servicing Agent may periodically waive all or a portion of its
respective shareholder servicing fees with respect to the Fund to increase the
net income of the Fund available for distribution as dividends.
CUSTODIAN, TRANSFER AGENT AND DIVIDEND DISBURSING AGENT
Key Trust Company of Ohio, N.A., 127 Public Square, Cleveland, Ohio
44114 has been retained as Custodian for the Funds' investments. Key Trust
Company of Ohio, N.A. also maintains certain accounting and financial records of
the Funds. Key Trust Company of Ohio, N.A. is a subsidiary of KeyCorp and an
affiliate of the Adviser and receives compensation from the Funds for services
it performs as Custodian. State Street Bank and Trust Company, 225 Franklin
Street, Boston, MA 02110 is Transfer Agent for the Funds and receives a fee for
this service. Boston Financial Data Services, Inc., Two Heritage Drive, Quincy,
MA 02171 acts as Dividend Disbursing Agent for the shares of the Funds and
receives a fee for this service.
PERFORMANCE INFORMATION
From time to time the "standardized yield," "dividend yield," "average
annual total return" and "total return" of an investment in Fund shares may be
advertised. An explanation of how yields and total returns are calculated and
the components of those calculations are set forth below.
Yield and total return information may be useful to investors in
reviewing a Fund's performance. A Fund's advertisement of its performance must,
under applicable Commission rules, include the average annual total returns for
the Fund for the 1, 5 and 10-year period (or the life of the Fund, if less) as
of the most recently ended calendar quarter. This enables as investor to compare
a Fund's performance to the performance of other funds for the same periods.
However, a number of factors should be considered before using such information
as a basis for comparison with other investments. An investment in a Fund is not
insured; yield and total return are not guaranteed and normally fluctuate on a
daily basis. Yield and total return for any given past period are not a
prediction or representation by the Company of future yields or rates of return
on its shares. The yield and total return of a Fund are affected by the types of
investments the Fund holds, operating expenses and credit or interest rate risk.
When redeemed, an investor's shares may be worth more or less than their
original cost.
STANDARDIZED YIELDS. A Fund's "yield" (referred to as "standardized
yield") for a given 30-day period for the shares of a Fund is calculated using
the following formula set forth in rules adopted by the Commission that apply to
all funds that quote yields:
Standardized Yield = 2[(a-b+1) to the 6th power-1]
cd
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The symbols above represent the following factors:
a = dividends and interest earned during the 30-day period.
b = expenses accrued for the period (net of any expense
reimbursements).
c = the average daily number of shares of the Fund outstanding during
the 30-day period that were entitled to receive dividends.
d = the maximum offering price per share on the last day of the period,
adjusted for undistributed net investment income.
The standardized yield for a 30-day period may differ from its yield
for any other period. The Commission formula assumes that the standardized yield
for a 30-day period occurs at a constant rate for a six-month period and is
annualized at the end of the six-month period. This standardized yield is not
based on actual distributions paid by the Fund to shareholders in the 30-day
period, but is a hypothetical yield based upon the net investment income from
the Fund's portfolio investments calculated for that period. The standardized
yield may differ from the "dividend yield," described below.
DIVIDEND YIELD AND DISTRIBUTION RETURN. From time to time a Fund may
quote a "dividend yield" or a "distribution return." Dividend yield is based on
the share dividends derived from net investment income during a stated period.
Distribution return includes dividends derived from net investment income and
from realized capital gains declared during a stated period. Under those
calculations, the dividends and/or distributions declared during a stated period
of one year or less (for example, 30 days) are added together, and the sum is
divided by the maximum offering price per share on the last day of the period.
When the result is annualized for a period of less than one year, the "dividend
yield" is calculated as follows:
Dividends + Number of days (accrual period) x 365
Dividend Yield = ------------------
Max. Offering Price (last day of period)
TOTAL RETURN. The "average annual total return" is an average annual
compounded rate of return for each year in a specified number of years. It is
the rate of return based on the change in value of a hypothetical initial
investment of $1,000 ("P" in the formula below) held for a number of years ("n")
to achieve an Ending Redeemable Value ("ERV"), according to the following
formula:
ERV(1n)-1
(P) = Average Annual Total Return
The cumulative "total return" calculation measures the change in value
of a hypothetical investment of $1,000 over an entire period of years. Its
calculation uses some of the same factors
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as average annual total return, but it does not average the rate of return on an
annual basis. Total return is determined as follows:
ERV-P
P = Total Return
Total returns assume that all dividends and capital gains distributions
during the period are reinvested to buy additional shares at net asset value per
share, and that the investment is redeemed at the end of the period.
OTHER PERFORMANCE COMPARISONS. From time to time, a Fund may publish
the ranking of the performance of its shares by Lipper Analytical Services, Inc.
("Lipper"), a widely-recognized independent mutual fund monitoring service.
Lipper monitors the performance of regulated investment companies, including the
Funds, and ranks the performance of the Funds against [(i) all other funds,
excluding money market funds, and (ii) all other government bond funds.] The
Lipper performance rankings are based on a total return that includes the
reinvestment of capital gains distributions and income dividends but does not
take sales charges or taxes into consideration.
From time to time, a Fund may publish the ranking of the performance of
its shares by Morningstar, Inc., an independent mutual fund monitoring service
that ranks mutual funds, including the Funds, in broad investment categories
(equity, taxable bond, tax-exempt and other) monthly, based upon each funds'
three, five and ten-year average annual total returns (when available) and a
risk adjustment factor that reflects Fund performance relative to three-month
U.S. Treasury bill monthly returns. Such returns are adjusted for fees and sales
loads. There are five ranking categories with a corresponding number of stars:
highest (5), above average (4), neutral (3), below average (2) and lowest (1).
Ten percent of the funds, series or classes in an investment category receive 5
stars, 22.5% receive 4 stars, 35% receive 3 stars, 22.5% receive 2 stars, and
the bottom 10% receive one star.
From time to time, the yields and the total returns of the Funds may be
quoted in and compared to other mutual funds with similar investment objectives
in advertisements, shareholder reports or other communications to shareholders.
The Funds also may 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 the Fund would increase the value, not only of
the original Fund investment, but also of the additional Fund shares received
through reinvestment. As a result, the value of the Fund investment would
increase more quickly than if dividends or other distributions had been paid in
cash. A Fund may also include discussions or illustrations of the potential
investment goals of a prospective investor (including but not limited to tax
and/or retirement planning), investment management techniques, policies or
investment suitability of Fund, economic conditions, legislative developments
(including pending legislation), the effects of
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<PAGE> 87
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, 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. A Fund also may 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 stock, bonds, Treasury
bills and shares of the Fund as well as charts or graphs which illustrate
strategies such as dollar cost averaging, and comparisons of hypothetical yields
of investment in tax-exempt versus taxable investments. In addition,
advertisements or shareholder communications may include a discussion of certain
attributes or benefits to be derived by an investment in a Fund. Such
advertisements or communications may include symbols, headlines or other
material which highlight or summarize the information discussed in more detail
therein. With proper authorization, a Fund may reprint articles (or excerpts)
written regarding a Fund and provide them to prospective shareholders.
Investors also may judge, and the Funds may at times advertise
performance by comparing it to the performance of other mutual funds or mutual
fund portfolios with comparable investment objectives and policies, which
performance may be contained in various unmanaged mutual fund or market indices
or rankings such as those prepared by Dow Jones & Co., Inc., Standard & Poor's
Corporation, Lehman Brothers, Merrill Lynch, and Salomon Brothers, and in
publications issued by Lipper Analytical Services, Inc. and in the following
publications: IBC Money Fund Reports, Value Line Mutual Fund Survey, Ibottson
Associates, Morningstar, CDA/Wiesenberger, Money Magazine, Forbes, Barron's, The
Wall Street Journal, The New York Times, Business Week, American Banker,
Fortune, Institutional Investor and U.S.A. Today. In addition to yield
information, general information about the Funds that appears in a publication
such as those mentioned above may also be quoted or reproduced in advertisements
or in reports to shareholders.
Advertisements and sales literature may include discussions of
specifics of the portfolio manager's investment strategy and process, including,
but not limited to, descriptions of security selection and analysis.
Advertisements may also include descriptive information about the
investment adviser, including, but not limited to, its status within the
industry, other services and products it makes available, total assets under
management and its investment philosophy.
When comparing yield, total return and investment risk of an investment
in a Fund with other investments, investors should understand that certain other
investments have different risk characteristics than an investment in shares of
the Fund. For example, certificates of deposit may have fixed rates of return
and may be insured as to principal and interest by the FDIC, while a Fund's
returns will fluctuate and its share values and returns are not guaranteed.
Money market accounts offered by banks also may be insured by the FDIC and may
offer stability of principal.
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U.S. Treasury securities are guaranteed as to principal and interest by the full
faith and credit of the U.S. government. Money market mutual funds seek to offer
a fixed price per share.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Pursuant to the Investment Advisory Agreement, KMFA determines, subject
to the general supervision of the Directors of the Company, and in accordance
with each Fund's investment objective and restrictions, which Underlying
Portfolio shares or securities are to be purchased or sold by a Fund, and which
brokers are to be eligible to execute its portfolio transactions. Purchases from
underwriters and/or broker dealers of portfolio securities include a commission
or concession paid by the issuer to the underwriter and/or broker/dealer and
purchases from dealers serving as market makers may include the spread between
bid and asked price. At times, the Funds may also purchase portfolio securities
directly from dealers acting as principals, underwriters or market makers. As
these transactions are usually conducted on a net basis, no brokerage
commissions are paid by a Fund. While KMFA generally seeks competitive prices
(inclusive of any spread or commission), a Fund may not necessarily pay the
lowest prices available on each transaction, for reasons discussed below.
Allocation of transactions to dealers is determined by KMFA in its best
judgment and in a manner deemed fair and reasonable to shareholders. The primary
consideration is prompt execution of orders in an effective manner at the most
favorable price. In assessing the best overall terms available for any
transaction, KMFA considers all 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, research services
provided to KMFA and the reasonableness of the commission, if any, both for the
specific transaction and on a continuing basis.
In selecting brokers or dealers qualified to execute a particular
transaction, brokers or dealers may be selected who provide brokerage and
research services (as those terms are defined in Section 28(e) of the Securities
Exchange Act of 1934) to KMFA, the Funds or other accounts over which KMFA
exercises investment discretion. Research so received is in addition to and not
in lieu of services required to be performed by KMFA and does not reduce the
advisory fees payable to KMFA by the Funds. Such information may be useful to
KMFA in serving both the Funds and other clients and, conversely, such
supplemental research information obtained by the placement of orders on behalf
of other clients may be useful to KMFA in carrying out its obligations to the
Funds. The Investment Advisory Agreement authorizes KMFA to pay a broker or
dealer who provides such brokerage and research services a commission for
executing a portfolio transaction for a Fund which is in excess of the amount of
commission another broker or dealer would have charged for effecting that
transaction if KMFA determines in good faith that the total commission is
reasonable in relation to the value of the brokerage and research services
provided by such broker or dealer, viewed in terms of either that particular
transaction or the overall responsibilities of KMFA with respect accounts over
which it exercises investment discretion.
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The Funds will not execute portfolio transactions through, make savings
deposits in, or enter into repurchase or reverse repurchase agreements with
KMFA, Key Trust Company of Ohio, N.A. or its affiliates, BISYS, Victory
Broker-Dealer Services, Inc. or their affiliates, and will not give preference
to Key Trust Company of Ohio, N.A.'s correspondent banks or affiliates, or BISYS
or Victory Broker-Dealer Services, Inc. with respect to such transactions,
securities, savings deposits, repurchase agreements and reverse repurchase
agreements.
Investment decisions for the Funds are made independently from those
made for other funds or any other investment company or account managed by KMFA.
Any such other investment company or account may also invest in the same
securities as a particular Fund. When a purchase or sale of the same security is
made at substantially the same time on behalf of a Fund and another Fund or
investment company or account, the transaction will be averaged as to price, and
available investments allocated as to amount, in a manner which KMFA believes to
be equitable to the Fund and such other Fund or investment company or account.
In some instances, this investment procedure may adversely affect the price paid
or received by the Fund or the size of the position obtained by the Fund. To the
extent permitted by law, KMFA may aggregate the securities to be sold or
purchased for a Fund with those to be sold or purchased for the other Funds or
for other investment companies or accounts in order to obtain best execution. As
provided in the Investment Advisory Agreement, in making investment
recommendations for the Funds, KMFA will not inquire or take into consideration
whether an issuer of securities proposed for purchase or sale by a Fund is a
customer of KMFA, its parents or subsidiaries or affiliates and, in dealing with
their commercial customers, KMFA, its parents, subsidiaries, and affiliates will
not inquire or take into consideration whether securities of such customers are
held by the Funds.
PURCHASE, REDEMPTION AND PRICING
The methods of purchase and redemption of shares, and special
retirement, withdrawal and exchange plans offered are fully set forth in the
Prospectus. Certain additional information is provided below.
The Funds 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 (the "NYSE") is restricted by applicable rules and regulations of the
SEC, (b) the NYSE 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.
Pursuant to Rule 11a-3 under the 1940 Act, a Fund is required to give
shareholders at least 60 days' notice prior to terminating or modifying its
exchange privilege. Under the Rule, the 60-day notification requirement may be
waived if (1) the only effect of a modification would be to reduce or eliminate
an administrative fee, redemption fee, or deferred sales charge ordinarily
payable at the time of exchange, or (2) a Fund temporarily suspends the offering
of shares as permitted under the 1940 Act or by the SEC, or because it is unable
to invest amounts effectively in accordance with its investment objective and
policies.
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<PAGE> 90
The Company and KMFA reserve the right at any time without prior notice
to shareholders to refuse exchange purchases by any person or group if, in the
judgment of KMFA, a Fund would be unable to invest effectively in accordance
with its investment objective and policies, or would potentially be adversely
affected.
As indicated in the Prospectus, the net asset value of each Fund is
determined and the shares of each Fund are priced as of the close of regular
trading of the NYSE ("the Valuation Time") on each Business Day of the Fund. A
"Business Day" is a day on which the NYSE is open for trading. The NYSE is
closed in observance of the following holidays: New Year's Day, President's Day,
Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving and
Christmas.
The net asset value of the shares of each Fund is normally determined
at 4:00 p.m., Eastern Standard Time, each Business Day, and each is determined
by dividing the total value of all underlying mutual fund shares and securities
held (both valued at current market value or by other method approved by the
respective Board of the Proprietary Portfolios), and other assets, less
liabilities, divided by the total number of shares then outstanding. Securities
traded on securities exchanges or the NASDAQ national market are valued at the
last sales price on the exchange where the security is primarily traded or,
lacking any sales, at the mean between the most recent bid and asked quotation.
Securities traded over-the-counter are valued at the mean between the most
recent bid and asked price. Securities for which quotations are not readily
available and any other assets are valued at fair value as determined in good
faith by the Board of Directors. Money market instruments are valued at market
value except money market instruments having a maturity of less than 60 days
which are valued at amortized cost. The amortized cost method values a security
initially at its cost and thereafter assumes a constant amortization of any
discount or premium regardless of the impact of fluctuating interest rates on
the market value of the security. This method does not take into account
unrealized gains or losses.
REDEMPTIONS-IN-KIND. Although not currently contemplated by the Funds, from time
to time a Fund may elect to make an in-kind redemption of portfolio securities
to shareholders. In that event, a shareholder could expect to incur brokerage
fees upon disposal of such securities.
FEDERAL INCOME TAXES
The Prospectus describes generally the tax treatment of distributions
by each Fund. This section of the Statement of Additional Information includes
additional information concerning federal income taxes.
Qualification as a "regulated investment company" under the Code
requires, among other items, that (a) at least 90% of each Fund's annual gross
income be derived from interest; payments with respect to securities loans;
dividends and gains from the sale or other disposition of securities, or foreign
currencies, or other income (including but not limited to gains from options,
futures, or forward contracts) derived with respect to each Fund's business of
investing in such
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securities or currencies; (b) each Fund generally derives less than 30% of its
gross income from gains from the sale or other disposition of securities,
options, futures or forward contracts held for less than three months; and (c)
each Fund diversifies its holdings so that, at the end of each quarter of the
taxable year, (i) at least 50% of the market value of each Fund's assets is
represented by cash, government securities and other securities limited in
respect of any one issuer to an amount not greater than 5% of each Fund's assets
and 10% of the outstanding voting securities of such issuer, and (ii) not more
than 25% of the value of its assets is invested in the securities of any one
issuer (other than U.S. Government securities and the securities of other
regulated investment companies), or of two or more issuers which the taxpayer
controls and which are determined to be engaged in the same or similar trades or
businesses or related trades or businesses. Each Fund generally intends to
satisfy these qualification requirements by investing in the underlying mutual
funds. As a regulated investment company, each Fund will not be subject to
federal income tax on its investment company taxable income and net capital
gains distributed to its shareholders, provided that it distributes to its
shareholders at least 90% of its investment company taxable income (including
its net tax-exempt income) earned in each year.
Dividends received from an underlying mutual fund are taxable as
ordinary income to a Fund which invests in the underlying mutual fund.
Distributions from an underlying mutual fund designated as capital gain
distributions are taxable as long-term capital gains, regardless of how long the
Fund invests in the underlying mutual fund.
Income and dividends received by regulated investment company from
sources within foreign countries may be subject to withholding and other taxes
imposed by such countries. Tax conventions between certain countries and the
United States may reduce or eliminate such taxes. Because not more than 50% of
the value of the total assets of any Fund is expected to consist of securities
of foreign issuers, no Fund will be eligible to elect to "pass through" foreign
tax credits to shareholders.
Gains or losses on sales of portfolio securities by a regulated
investment company generally will be long-term capital gains or losses if the
securities have been held by it for more than one year, except in certain cases
including where the regulated investment company acquires a put or grants a call
thereon. Gain recognized on the disposition of a debt obligation (including
tax-exempt obligations purchased after April 30, 1993) purchased by the
regulated investment company at a market discount (generally, at a price less
than its principal amount) will generally be treated as ordinary income to the
extent of the portion of the market discount which accrued during the period of
time the regulated investment company held the debt obligation. Other gains or
losses on the sale of securities will be short-term capital gains or losses. To
the extent that a Fund recognizes long-term capital gains, such gains will be
distributed at least annually. Such distributions not later than 60 days after
the close of the Fund's taxable year, and taxable to shareholders as long-term
capital gains, regardless of how long a shareholder has held Fund shares. If a
shareholder receives a designated capital gain distribution on a Fund share and
such Fund share is held for six months or less, then (unless otherwise
disallowed) any loss on the sale or exchange of that Fund share will be treated
as a long-term capital loss to the extent of the designated capital gain
distribution thereon. In addition, any loss realized by a shareholder upon
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the sale or redemption of Fund shares held less than six months will be
disallowed to the extent of any tax-exempt interest dividends. These rules shall
not apply, however, to losses incurred under a periodic redemption plan.
If a shareholder disposes of Fund shares with reinvestment rights
within 90 days of acquiring such shares, and subsequently reacquires Fund shares
or shares of another regulated investment company with a reduced or eliminated
sales charge pursuant to the reinvestment rights, the sales charge incurred, if
any, to acquire the disposed shares (to the extent such previous sales charges
do not exceed the reduction or elimination of sales charges incurred on the
subsequent acquisition) shall not be taken into account for the purpose of
determining the amount of gain or loss on initial disposition. To the extent any
sales charge is consequently not taken into account it will be treated as having
been incurred in the subsequent acquisition. In addition, any loss realized on a
redemption or exchange of shares of a Fund will be disallowed to the extent that
substantially identical shares are reacquired within the 61-day period beginning
30 days before and ending 30 days after the shares are disposed of.
As of the printing of this Statement of Additional Information, the
maximum individual tax rate applicable to ordinary income is 39% (marginal rates
may be higher for some individuals due to phase out of exemptions and
elimination of deductions); the maximum individual tax rate applicable to net
realized capital gains is 28%; and the maximum corporate tax rate applicable to
ordinary income and net realized capital gains is 35% (however, to eliminate the
benefit of lower marginal corporate income tax rates, corporations which have
taxable income greater than $100,000 for a taxable year will be required to pay
an additional amount of income tax of up to $11,750 and corporations which have
taxable income greater than $15,000,000 for a taxable year will be required to
pay an additional amount of income tax of up to $100,000).
Individuals who are not active participants (and who do not have a
spouse who is an active participant) in certain types of retirement plans
("qualified retirement plans") may deduct contributions to an individual
retirement account ("IRA"), up to specified limits. Investment earnings in an
IRA will be tax-deferred until withdrawn. The maximum annual deductible
contribution to an IRA for individuals under age seventy and a half is 100% of
includible compensation up to a maximum of (i) $2,000 for single individuals;
(ii) $4,000 for a married couple when both spouses earn income; and (iii) $2,250
when one spouse earns, or elects for IRA purposes to be treated as earning no
income (together the "IRA contribution limits").
The IRA deduction is also available for single individual taxpayers and
married couples who are active participants in qualified retirement plans but
who have adjusted gross incomes which do not exceed certain specified limits. If
their adjusted gross income exceeds these limits, the amount of the deductible
contribution is phased down and eventually eliminated.
Any individual who works may make nondeductible contributions to an IRA
in addition to any deductible contributions. Total aggregate deductible and
nondeductible contributions are limited to the IRA contribution limits discussed
above. Nondeductible contributions in excess of the applicable IRA contribution
limit are "nondeductible excess contributions". In addition, contributions made
to an IRA for the year in which an individual attains the age of seventy and a
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half, or any year thereafter, are also nondeductible excess contributions.
Nondeductible excess contributions are subject to a 6% excise tax penalty which
is charged each year that the nondeductible excess contribution remains in the
IRA.
An employer also may contribute to an individual's IRA by establishing
a Simplified Employee Pension Plan, known as a SEP-IRA. Participating employers
may make an annual contribution in an amount up to the lesser of 15% of earned
income or $30,000, subject to certain provisions of the Code. Investment
earnings will be tax-deferred until withdrawn.
The foregoing discussion regarding IRAs is based upon the Code and
federal regulations in effect as of the date of this Statement of Additional
Information and summarizes only some of the important federal income tax
considerations generally effecting IRA contributions made by individuals or
their employers. It is not intended as a substitute for careful tax planning.
If an option granted by a regulated investment company lapses or is
terminated through a closing transaction, such as a repurchase by the regulated
investment company of the option from its holder, the regulated investment
company will realize a short-term capital gain or loss, depending on whether the
premium income is greater or less than the amount paid by the regulated
investment company in the closing transaction. Recognition of capital losses may
be deferred if they result from a position that is part of a tax "straddle,"
discussed below. If securities are sold by a regulated investment company
pursuant to the exercise of a call option granted by it, such regulated
investment company will add the premium received to the sale price of the
securities delivered in determining the amount of gain or loss on the sale. If
securities are purchased by the regulated investment company pursuant to the
exercise of a put option granted by it, such regulated investment company will
subtract the premium received from its cost basis in the securities purchased.
Under Section 1256 of the Code, gain or loss recognized by a regulated
investment company from certain financial forward, futures and options
transactions is treated as 60% long-term capital gain (or loss) and 40%
short-term capital gain (or loss) (the "60%/40% Rule"). Gain or loss may arise
upon the exercise or lapse of such forward contracts, futures and options as
well as from closing transactions. In addition, any such forward contracts,
futures or options remaining unexercised at the end of the regulated investment
company's taxable year are treated as sold for their then fair market value,
resulting in additional gain or loss to the regulated investment company
characterized in the manner described above (the "Mark-to-Market Rule").
Transactions that qualify as designated hedges are excepted from the
Mark-to-Market Rule and the 60%/40% Rule. Moreover, all or a portion of the gain
realized from engaging in "conversion transactions" may be treated as ordinary
income under Section 1258 of the Code. Conversion transactions are defined to
include certain forward, futures, option and straddle transactions, transactions
marketed or sold to produce capital gains, or transactions described in Treasury
regulations to be issued in the future. Finally, "currency transactions" may be
subject to Section 988 of the Code, under which foreign currency gains or losses
would generally be computed separately and treated as ordinary income or losses.
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Offsetting positions held by a regulated investment company involving
certain financial forward, futures or option contracts may be considered, for
tax purposes, to constitute "straddles." Straddles are defined to include
"offsetting positions" in actively traded personal property. The tax treatment
of straddles is governed by Section 1092 of the Code which, in certain
circumstances, overrides or modifies the provisions of Section 1256, discussed
above. If a regulated investment company were treated as entering into straddles
by reason of its engaging in certain financial forward, futures or option
contracts, such straddles may be characterized as "mixed straddles" if the
futures, forwards, or options comprising a part of such straddles were governed
by Section 1256 of the Code. A regulated investment company may make one or more
elections with respect to mixed straddles, and, depending upon which elections
are made, if any, the tax consequences of the transaction may differ. Generally,
to the extent the straddle rules apply to positions established by a regulated
investment company, losses realized by the regulated investment company may be
deferred to the extent of unrealized gain in any offsetting positions. Moreover,
as a result of the straddle and the conversion transaction rules, short-term
capital loss on straddle positions may be recharacterized as long-term capital
loss and long-term capital gain may be characterized as short-term capital gain
or ordinary income.
Foreign Shareholders. Under the Code, distributions of net investment
income by a regulated investment company to a non-resident alien individual,
non-resident alien fiduciary of a trust or estate, foreign corporation, or
foreign partnership will be subject to a U.S. withholding tax (at a rate of 30%
or a lower treaty rate). Withholding will not apply if a dividend paid by a
regulated investment company to a foreign shareholder is "effectively connected"
with a U.S. trade or business, in which case the reporting and withholding
requirements applicable to U.S. citizens, U.S. residents or domestic
corporations will apply. Distributions of net long-term capital gains are not
subject to tax withholding, but, in the case of a foreign shareholder who is a
non-resident alien individual, such distributions ordinarily will be subject to
U.S. withholding tax at a rate of 30% if the individual is physically present in
the U.S. for more than 182 days during the taxable year.
OTHER MATTERS. Investors should be aware that the investments to be
made by a regulated investment company may involve sophisticated tax rules such
as the original issue discount, real estate mortgage investment conduit,
("REMIC"), subpart F income, and passive foreign investment company rules that
would result in income or gain recognition by the regulated investment company
without corresponding, current cash receipts. Where a regulated investment
company recognizes noncash income, the regulated investment company may
distribute cash derived from other sources in order to meet the minimum
distribution requirements described above.
ADDITIONAL INFORMATION
The Company is an open-end management investment company organized as a
corporation under the laws of the State of Maryland on May 26, 1983. The Company
offers shares of common stock which represent interests in one of nine separate
portfolios. This SAI relates to the following Funds of the Company: Growth Fund,
Moderate Growth Fund and Conservative Growth Fund. Each Fund offers only one
class of shares. Shares of each Fund of the Company
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<PAGE> 95
are redeemable at the net asset value thereof at the option of the holders
thereof or in certain circumstances at the option of the Company. For
information concerning the methods of redemption and the rights of shares
ownership, see the Prospectus under the caption "Redeeming Shares."
Generally, on each matter submitted to a vote of shareholders, each
shareholder is entitled to one vote per share. In addition, all shares of each
Fund vote as a single class; provided, however, that (i) as to any matter with
respect to which a separate vote of any Fund is required by the 1940 Act or
under the Maryland General Corporation law, the requirements as to a separate
vote by that Fund apply in lieu of single class voting; (ii) in the event that
the separate vote requirements referred to in (i) apply with respect to one or
more Funds, then, subject to (iii) below, the shares of all other Funds vote as
a single class; and (iv) as to any matter which does not affect the interest of
a particular Fund, only the holders of shares of the one or more affected Funds
are entitled to vote. And, notwithstanding any provision of the Maryland General
Corporation Law requiring a greater portion than a majority of the votes
entitled to be cast in order to take or authorize any action, any such action
may be taken or authorized upon the concurrence of a majority of the aggregate
number of votes entitled to be cast thereon.
Shares of the Funds have no subscription or preemptive rights and only
such conversion or exchange privileges as the Directors may grant in their
discretion.
INDEPENDENT ACCOUNTANTS AND REPORTS
At least semi-annually, the Company will furnish the shareholders of
the Funds with financial statements for the Funds. The annual financial
statements of the Funds will be audited by the Company's independent
accountants. The Board of Directors has selected Price Waterhouse LLP, 1177
Avenue of the Americas, New York, New York 10036 as independent accountants to
audit the Funds' financial statements and review the Funds' tax returns for
fiscal years ending on or after November 30, 1996.
COUNSEL
Morrison & Foerster LLP, 2000 Pennsylvania Avenue NW, Washington, D.C.
20006, serves as legal counsel to the Company.
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APPENDIX A
MOODY'S INVESTORS SERVICE, INC. ("MOODY'S")
MOODY'S BOND RATINGS
Aaa Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred
to as "gilt edge." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be
visualized are most unlikely to impair the fundamentally strong
positions of such issues.
Aa Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally
known as high grade bonds. They are rated lower than the best bonds
because margins of protection may not be as large as in Aaa securities
or fluctuation of protective elements may be of greater amplitude or
there may be other elements present which make the long-term risks
appear somewhat larger than in Aaa securities.
A Bonds which are rated A possess many favorable investment attributes
and are 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
some time in the future.
Baa Bonds which are rated Baa are considered as medium grade obligations
(i.e., they are neither highly protected nor poorly secured). Interest
payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding
investment characteristics and in fact have speculative characteristics
as well.
Bonds rated Aaa, Aa, A and Baa are considered investment grade bonds.
Rating Refinements: Moody's may apply numerical modifiers, 1, 2 and 3
in each generic rating classification from Aa through B in its
corporate and municipal bond rating system. The modifier 1 indicates
that the security ranks in the higher end of its generic rating
category; the modifier 2 indicates a mid-range ranking; and a modifier
3 indicates that the issue ranks in the lower end of its generic rating
category.
MOODY'S SHORT-TERM DEBT RATINGS
Moody's Short-Term Debt Ratings are opinions of the ability of issuers
to repay punctually senior debt obligations which have an original maturity not
exceeding one year. Moody's employs the following three designations, all judged
to be investment grade, to indicate the relative repayment capacity of rated
issuers: Prime-1, Prime-2 and Prime-3.
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<PAGE> 97
Issuers rated Prime-1 have a superior ability for repayment of senior
short-term debt obligations. Issuers rated Prime-2 have a strong ability for
repayment of senior short-term debt obligations; and issuers rated Prime-3 have
an acceptable ability for repayment of senior short-term debt obligations.
Issuers rated Not Prime do not fall within any of the Prime rating categories.
STANDARD & POOR'S CORPORATION ("STANDARD & POOR'S")
STANDARD & POOR'S BOND RATINGS
A Standard & Poor's rating is a current assessment of the
creditworthiness of an obligor with respect to a specific obligation. This
assessment may take into consideration obligors such as guarantors, insurers or
lessees.
The ratings are based on current information furnished by the issuer or
obtained by Standard & Poor's from other sources it considers reliable. The
ratings are based, in varying degrees, on the following considerations: (1)
likelihood of default capacity and willingness of the obligor as to the timely
payment of interest and repayment of principal in accordance with the terms of
the obligation; (2) nature of and provisions of the obligation; and (3)
protection afforded by, and relative position of, the obligation in the event of
bankruptcy, reorganization or other arrangement under the laws of bankruptcy and
other laws affecting creditors' rights.
Standard & Poors does not perform an audit in connection with any
rating and may, on occasion, rely on unaudited financial information. The
ratings may be changed, suspended or withdrawn as a result of changes in, or
unavailability of, such information, or for other reasons.
AAA Debt rated "AAA" has the highest rating assigned by Standard & Poor's.
Capacity to pay interest and repay principal is extremely strong.
AA Debt rated "AA" has a very strong capacity to pay interest and repay
principal and differs from the highest rated issues only in small
degree.
A Debt rated "A' has a strong capacity to pay interest and repay
principal although they are somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than debt
in the higher-rated categories.
BBB Debt rated "BBB' is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate
protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay
interest and repay principal for debt in this category than for debt in
higher-rated categories.
Bonds rated AAA, AA, A and BBB are considered investment grade bonds.
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<PAGE> 98
NR Indicates that no rating has been requested, that there is insufficient
information on which to base a rating or that Standard & Poor's does
not rate a particular type of obligation as a matter of policy.
STANDARD & POOR'S COMMERCIAL PAPER RATINGS
A Standard and Poor's commercial paper rating is a current assessment
of the likelihood of timely payment of debt considered short-term in the
relevant market. The commercial paper rating is not a recommendation to
purchase, sell, or hold a security, inasmuch as it does not comment as to market
price or suitability for a particular investor. The ratings are based upon
current information furnished to S&P by the issuer or obtained by S&P from other
sources it considers reliable. The ratings may be changed, suspended or
withdrawn as a result of changes in or unavailability of such information, or
based on other circumstances. Ratings are graded into two group categories,
ranging from "A" for the highest quality obligations to "D" for the lowest. The
categories are as follows:
Issues assigned A ratings are regarded as having the greatest capacity
for timely payment. Issues in this category are further refined with the
designation 1, 2 or 3 to indicate the relative degree of safety.
A-1 This highest category indicates that the degree of safety regarding
timely payment is strong.
A-2 Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as
for issues designated A-1.
A-3 Issues carrying this designation have adequate capacity for timely
payment. They are, however, more vulnerable to the adverse effects of
changes in circumstances than obligations carrying the higher
designations.
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<PAGE> 99
PART C
OTHER INFORMATION
ITEM 24. FINANCIAL STATEMENTS AND EXHIBITS.
(a) Financial Statements:
Incorporated by Reference in Part B:
Audited Financial Statements, including:
Statements of Investments, November 30, 1995
Statements of Assets and Liabilities, November 30, 1995
Statements of Operations, November 30, 1995
Statements of Changes in Net Assets for the years ended
November 30, 1995 and 1994
Financial Highlights
Notes to Financial Statements
Report of Independent Accountants dated January 17, 1996
(b) Exhibits:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<S> <C>
1 -- Articles of Incorporation, as amended and supplemented*
2(a) -- By-Laws.*
(b) -- By-Laws, as amended.*
3 -- None.
4 -- None.
5(a) -- Investment Advisory Agreement.*
(b) -- Investment Advisory Agreement, as amended.*
(c) -- Proposed Advisory Agreement (for SBSF Fund, SBSF Money
Market Fund, SBSF Convertible Securities Fund and SBSF
Capital Growth Fund).*
(d) -- Form of Investment Advisory Agreement (for Key Stock
Index Fund and Key International Index Fund).*
6 -- None.
7 -- None.
8(a) (i) -- Form of Custody Agreement.*
(a) (ii) -- Custody Agreement*
(b) -- Form of Transfer Agency Agreement.*
9(a) -- Administration Agreement.*
(b) -- Administration Agreement, as amended.*
(c) -- Proposed Administration Agreement.*
(d) -- Form of Administration Agreement.*
(e) -- Form of Fund Accounting Agreement.*
10 -- Opinion of Counsel, filed herewith.
11 -- Consent of Independent Accountants, filed herewith.
12 -- None.
13 -- Investment Representation Letter.*
14 -- None.
15(a) -- Distribution Plan pursuant to Rule 12b-1.*
(b) -- Distribution Plan pursuant to Rule 12b-1, as amended.*
(c) -- Distribution Plan pursuant to Rule 12b-1, as amended,
for Key International Index Fund.*
(d) -- Shareholder Servicing Plan and related form of
Shareholder Servicing Agreement for Key International
Index Fund.*
16 -- Not Applicable.
</TABLE>
* Previously filed.
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<PAGE> 100
ITEM 25. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT.
No person is controlled by or under common control with Registrant.
ITEM 26. NUMBER OF HOLDERS OF SECURITIES.
Number of Record Holders as of April 30, 1996: SBSF Fund 1,121 record
holders; SBSF Convertible Securities Fund 492 record holders; SBSF Capital
Growth Fund 294; and SBSF Money Market Fund 259 record holders.
ITEM 27. INDEMNIFICATION.
The Corporation shall indemnify directors, officers, employees and
agents of the Corporation against judgments, fines, settlements and expenses
(including attorney's fees) to the fullest extent authorized, and in the manner
permitted, by applicable federal and state law, except that such indemnification
will not be permitted if, in the opinion of the Board of Directors, such
indemnification would be inconsistent with the position of the staff of the
Securities and Exchange Commission (the "Commission") in its interpretive
releases relating to matters of indemnification, including Investment Company
Act Release No. 11330 (September 4, 1980) for so long as such releases remain
the position of the staff of the Commission. Insofar as indemnification for
liabilities arising under the Securities Act of 1933 may be permitted to
directors, officers or persons controlling the Registrant pursuant to the
foregoing provisions, the Registrant has been informed that in the opinion of
the Securities and Exchange Commission such indemnification is against public
policy as expressed in the Act and is therefore unenforceable.
ITEM 28. BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER.
See information set forth under the caption "Investment Adviser" in the
Prospectus and the Statement of Additional Information.
KeyCorp Mutual Fund Advisers, Inc. ("KMFA") is the investment adviser
to each fund of the Victory Portfolios. KMFA is a wholly owned indirect
subsidiary of KeyCorp, a bank holding company which had total assets of
approximately $68 billion as of September 30, 1995 and is also a wholly owned
indirect subsidiary of KeyBank National Association. KeyCorp is a leading
financial institution doing business in 26 states from Maine to Alaska,
providing a full array of trust, commercial, and retail banking services. Its
non-bank subsidiaries include investment advisory, securities brokerage,
insurance, bank credit card processing, mortgage and leasing companies. As of
March 31, 1996, KMFA and its affiliates have over $66 billion in assets under
management, and provide a full range of investment management services to
personal and corporate clients.
To the knowledge of Registrant, none of the directors or officers of
KMFA, except those set forth below, is or has been at any time during the past
two calendar years engaged in any other business, profession, vocation or
employment of a substantial
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<PAGE> 101
nature, except that certain directors and officers of KMFA also hold positions
with KeyCorp or its subsidiaries.
The principal executive officers and directors of KMFA are as follows:
W. Christopher Maxwell, Director, Chairman and Chief Executive
Officer. Also Executive Vice President of KeyCorp Management
Company ("KMC").
Kathleen A. Dennis, Director and President. Also Senior Vice
President of KMC.
Martin J. Walker, Director. Also Chairman, President and Chief
Executive Officer of Society and Executive Vice President of
KeyCorp.
James W. Wert, Director. Also Senior Executive Vice President and
Chief Investment Officer of KeyCorp.
William G. Spears, Director. Also Chairman, Chief Executive and
Managing Director of Spears, Benzak, Salomon and Farrell, Inc.
("SBSF").
Linda A. Grandstaff, Director. Also Executive Vice President,
Commercial and International Services Group of KeyCorp.
Richard B. Ainsworth, Jr., Director. Also Executive Vice President
of Key Trust Company of Ohio, National Association.
Robert G. Jones, Director. Also Executive Vice President, Community
Banking, of KeyCorp.
Jack L. Kopnisky, Director. Also President, Key Investments, Inc.
John M. Keane, Vice President and Treasurer. Also Vice President,
KMC.
Charles G. Crane, Senior Vice President and Senior Management
Director. Also Senior Vice President and Managing Director SBSF.
Dennis M. Grapo, Senior Vice President and Senior Managing
Director. Also Senior Vice President and Senior Managing Director
of Society.
Frank J. Riccardi, Senior Vice President and Senior Managing
Director. Also Senior Vice President and Senior Managing Director
of Society.
Anthony Aveni, Senior Vice President and Senior Managing Director.
Also Senior Vice President and Senior Managing Director of Society.
60
<PAGE> 102
The business address of each of the foregoing individuals is 127 Public
Square, Cleveland, Ohio 44114.
ITEM 29. PRINCIPAL UNDERWRITERS.
(a) BISYS Fund Services, Limited Partnership ("BISYS Fund Services")
is expected to act as distributor and administrator for the
Registrant as of July 1, 1996. BISYS Fund Services also
distributes the securities of the American Performance Funds, the
AmSouth Mutual Funds, The ARCH Fund, Inc., The BB&T Mutual Funds
Group, The Coventry Group, the MarketWatch Funds, the MMA Praxis
Mutual Funds, M.S.D.&T. Funds, the Pacific Capital Funds, The
Parkstone Group of Funds, the Qualivest Funds, The Riverfront
Funds, Inc., The Sessions Group and the Summit Investment Trust,
each of which is an open-end management investment company.
(b) Partners of BISYS Fund Services, as of May 31, 1996, were as
follows:
<TABLE>
<CAPTION>
Name and Principal Positions and Offices with Positions and Offices with
Business Address BISYS Fund Services Registrant
- ------------------ -------------------------- --------------------------
<S> <C> <C>
BISYS Fund Services Inc. Sole General Partner None
3435 Stelzer Road
Columbus, OH 43219
WC Subsidiary Corporation Sole Limited Partner None
150 Clove Road
Little Falls, N.J. 07424
The BISYS Group, Inc. Sole Shareholder None
150 Clove Road
Little Falls, N.J. 07424
</TABLE>
ITEM 30. LOCATION OF ACCOUNTS AND RECORDS.
All accounts, books and other documents required to be maintained by
Section 31(a) of the 1940 Act and the Rules thereunder will be maintained at the
offices of:
(1) Key Mutual Funds, 45 Rockefeller Plaza, N.Y., N.Y. 10111;
(2) BFDS, State Street Bank and Trust Co., Two Heritage Drive, Quincy,
MA 02071 (records relating to their functions as Transfer Agent,
Dividend Disbursing Agent and Shareholder Servicing Agent);
(3) BISYS Fund Services, 3435 Stelzer Road, Columbus, Ohio 43219
(records relating to its functions as Administrator, Distributor
and Fund Accountant);
(4) Key Trust Company of Ohio, N.A., 127 Public Square, Cleveland,
Ohio, 44114 (records relating to its functions as Custodian); and
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<PAGE> 103
(5) KeyCorp Mutual Fund Advisers, Inc., 127 Public Square, Cleveland,
Ohio 44114-1306 (records relating to its functions as Investment
Adviser).
ITEM 31. MANAGEMENT SERVICES.
Other than as set forth under the captions "Investment Adviser" and
"Administrator" in Parts A and B of the Registration Statement, Registrant is
not a party to any management-related service contract.
ITEM 32. UNDERTAKINGS.
(a) Not applicable.
(b) Registrant undertakes to file a post-effective amendment with
respect to the Growth Fund, Moderate Growth Fund and Conservative Growth Fund,
using financial statements which need not be certified, within four to six
months of the effective date of the Registration Statement under the Securities
Act of 1933 for such Funds.
(c) Registrant undertakes to furnish each person to whom a prospectus
is delivered with a copy of the Registrant's latest annual report to
shareholders, when such annual report is issued, containing information called
for by Item 5A of Form N-1A, upon request and without charge.
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<PAGE> 104
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant has duly caused this
Post-Effective Amendment to its Registration Statement to be signed on its
behalf by the undersigned, thereunto duly authorized in the City of Cleveland,
and State of Ohio, on the 6th day of June, 1996.
SBSF FUNDS, INC.
By *
----------------------------------
Leigh A. Wilson
President
By /s/ Scott A. Englehart
----------------------------------
Scott A. Englehart
* Attorney-in-Fact
Pursuant to the requirements of the Securities Act of 1933, this
Post-Effective Amendment to Registrant's Registration Statement has been signed
below by the following individuals in the capacities indicated on the date
indicated.
SIGNATURE TITLE DATE
--------- ----- ----
*
- -------------------------
Leigh A. Wilson President and Director
(Principal Executive Officer) June 6, 1996
*
- -------------------------
Eugene J. McDonald Director June 6, 1996
*
- -------------------------
Frank A. Weil Non-Executive Chairman and
Director June 6, 1996
*
- -------------------------
Edward P. Campbell Director June 6, 1996
*
- -------------------------
Kevin L. Martin Treasurer (Principal Financial
Officer and Principal
Accounting Officer) June 6, 1996
/s/ Scott A. Englehart
- -------------------------
Scott A. Englehart
*Attorney-in-Fact
63
<PAGE> 105
INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION OF EXHIBIT
EX-99.B10 Opinion of Counsel
EX-99.B11 Consent of Independent Accountants
64
<PAGE> 106
EXHIBIT 99.B10
OPINION OF COUNSEL
<PAGE> 107
[MORRISON & FOERSTER LLP LETTERHEAD]
June 7, 1996
SBSF Funds, Inc.
45 Rockefeller Plaza
New York, NY 10111
Re: Post-Effective Amendment No. 22 to
SBSF Funds, Inc. Registration Statement on Form N-1A
Gentlemen:
We refer to Post-Effective Amendment No. 22 and Amendment No. 23 to the
Registration Statement on Form N-1A (SEC File No. 2-84920) (the "Registration
Statement") of SBSF Funds, Inc., a Maryland corporation (d/b/a Key Mutual Funds)
(the "Company"), relating to the registration of an indefinite number of shares
of common stock of three new portfolios proposed to be offered by the Company,
namely Key Growth Fund, Key Moderate Growth Fund and Key Conservative Growth
Fund (collectively, the "Shares").
We have been requested by the Company to furnish this opinion as
Exhibit 10 to the Registration Statement.
We have examined documents relating to the organization of the Company
and the authorization and issuance of shares of the Funds. We have also made
such inquiries of the Company and examined such questions of law as we have
deemed necessary for the purpose of rendering the opinion set forth herein. We
have assumed the genuineness of all signatures and the authenticity of all items
submitted to us as originals and the conformity with originals of all items
submitted to us as copies.
Based upon and subject to the foregoing, we are of the opinion that:
The issuance and sale of the Shares have been duly and validly
authorized by all appropriate corporate action, subject only to the filing of
Articles Supplementary with the State of Maryland, and assuming delivery of the
Shares by sale or in accord with the Company's dividend reinvestment plan in
accordance with the Company's then-current Registration Statement under the
Securities Act of 1933, the Shares will be validly issued, fully paid and
nonassessable.
We consent to the inclusion of this opinion as an exhibit to the
Registration Statement.
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<PAGE> 108
In addition, we consent to the use of our name and to the reference to
our firm under the heading "Counsel" in the Prospectus, which is included as
part of the Registration Statement.
Very truly yours,
/S/ Morrison & Foerster LLP
MORRISON & FOERSTER LLP
67
<PAGE> 1
EXHIBIT 99.B11
CONSENT OF INDEPENDENT ACCOUNTANTS
<PAGE> 2
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the reference to us under the heading "Independent
Accountants and Reports" in the Statement of Additional Information constituting
part of this Post-Effective Amendment No. 22 to the registration statement on
Form N-1A (the "Registration Statement") relating to the Key Growth Fund, Key
Moderate Growth Fund and Key Conservative Growth Fund (three of the portfolios
constituting the Key Mutual Funds (SBSF Funds, Inc.)).
/s/ Price Waterhouse LLP
Price Waterhouse LLP
New York, New York
June 5, 1996
69
