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- ---MAS------------------------------------------INSTITUTIONAL CLASS PROSPECTUS--
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MAS FUNDS
Targeted Duration Portfolio
September 28, 1998
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Client Services: 1-800-354-8185 Prices and Investment Results: 1-800-522-1525
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MAS Funds (the Fund) is a no-load mutual fund consisting of thirty-one
portfolios, one of which is described in this Prospectus. This Prospectus
offers the Institutional Class Shares of the Targeted Duration Portfolio (the
"portfolio").
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The portfolio may invest to varying degrees in high yield, high risk
securities which are speculative with regard to payment of interest and return
of principal (commonly referred to as junk bonds); therefore, investments in
this portfolio may not be suitable for all investors. See High Yield Investing
in the Glossary of Strategies for additional information regarding certain
risks associated with investment in such securities.
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PORTFOLIO PAGE REFERENCE
How to Use This Prospectus: 3
Portfolio Summary: 8
Prospectus Glossary:
Strategies 9
Investments 12
General Shareholder
Information: 23
Table of Contents: 37
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This Prospectus, which should be retained for future reference, sets forth
concisely information that you should know before you invest. A Statement of
Additional Information containing additional information about the Fund has
been filed with the Securities and Exchange Commission. Such Statement is
dated September 28, 1998 as revised from time to time, and has been incorporated
by reference into this Prospectus. A copy of the Statement may be obtained,
without charge, by writing to the Fund or by calling the Client Services Group
at the telephone number shown above.
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THE SECURITIES AND EXCHANGE COMMISSION HAS NOT APPROVED OR DISAPPROVED THE
FUND'S SHARES OR PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS.
ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
MILLER
ANDERSON
& SHERRERD, LLP ONE TOWER BRIDGE o WEST CONSHOHOCKEN, PA 19428 o 800-354-8185
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EXPENSE SUMMARY - INSTITUTIONAL CLASS SHARES
The following tables illustrate the various expenses and fees that a
shareholder in the portfolio will incur either directly or indirectly. The
Adviser may from time to time waive fees or reimburse expenses thereby
reducing total operating expenses.
Shareholder Transaction Expenses:
Sales Load Imposed on Purchases None
Sales Load Imposed on Reinvested Dividends None
Redemption Fees None
Exchange Fees None
Annual Fund Operating Expenses:
(as a percentage of average net assets after fee waivers)
12b-1 Fees None
Shareholder Servicing Fee None
Investment Total
Advisory Other Operating
Portfolio Fees Expenses Expenses
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Targeted Duration 0.255%* 0.195%** 0.450%
The Total Operating Expense ratios reflected in the table above may be higher
than the ratio of expenses actually deducted from portfolio assets because of
the effect of expense offset arrangements. The result of such arrangements is
to offset expenses that otherwise would be deducted from portfolio assets.
Amounts in the above table have been restated to reflect current fees and
expenses.
*Until further notice, the Adviser has voluntarily agreed to waive its
advisory fees and/or reimburse certain expenses to the extent necessary to
keep Total Operating Expenses actually deducted from portfolio assets for the
Targeted Duration Portfolio from exceeding 0.450%. Absent such waiver and/or
reimbursement by the Adviser, Total Operating Expenses would be 0.570% for the
Targeted Duration Portfolio.
**Other expenses are based on estimated amounts for the current year.
EXAMPLE
The purpose of this table is to assist in understanding the various expenses
that a shareholder in the portfolio will bear directly or indirectly. The
following example illustrates the expenses that an investor would pay on a
$1,000 investment over various time periods assuming (1) a 5% annual rate of
return, and (2) redemption at the end of each time period. The example should
not be considered a representation of past or future expenses and actual
expenses may be greater or less than those shown. Because the portfolio has
less than 10 months of operations, only the 1 and 3 year examples are shown,
which are based on estimated expenses.
Portfolio 1 year 3 year
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Targeted Duration $5 $14
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MAS Fund - 2 Terms in bold type are defined in the Prospectus Glossary
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HOW TO USE THIS PROSPECTUS
A PROSPECTUS SUMMARY begins on page 4;
A description of YIELD AND TOTAL RETURN begins on page 5;
GENERAL INFORMATION including INVESTMENT LIMITATIONS begins on page 6;
A SUMMARY PAGE for the portfolio's Objective, Policies and Strategies begins
on page 8;
The PROSPECTUS GLOSSARY which defines specific Allowable Investments, Policies
and Strategies printed in bold type throughout this Prospectus begins on page
9; and
GENERAL SHAREHOLDER INFORMATION begins on page 23.
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Terms in bold type are defined in the Prospectus Glossary MAS Fund - 3
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SUMMARY INFORMATION:
The following information should be read in conjunction with the specific
information about the portfolio.
OBJECTIVE: The portfolio seeks to achieve its investment objective relative to
the universe of securities in which it is authorized to invest and,
accordingly, the total return or current income achieved by the portfolio may
not be as great as that achieved by another portfolio that can invest in a
broader range of securities. The portfolio will seek to produce total return
by actively trading portfolio securities. The objective of the portfolio is
fundamental and may only be changed with approval of holders of a majority of
the shares of the portfolio. The achievement of the portfolio's objective
cannot be assured.
RISK FACTORS: Prospective investors in the Fund should consider the following
factors as they apply to the portfolio's allowable investments and policies.
See the Prospectus Glossary for more information on terms printed in bold
type:
o The portfolio may invest in Repurchase Agreements, which entail a risk of
loss should the seller default in its obligation to repurchase the
security which is the subject of the transaction;
o The portfolio may participate in a Securities Lending program which
entails a risk of loss should a borrower fail financially;
o Fixed-Income Securities will be affected by general changes in interest
rates resulting in increases or decreases in the value of the obligations
held by the portfolio. The value of Fixed-Income Securities can be
expected to vary inversely to changes in prevailing interest rates, i.e.,
as interest rates decline, market value tends to increase and vice versa.
Certain Fixed Income Securities may be highly sensitive to interest rate
changes, and highly sensitive to the rate of principal payments
(including prepayments on underlying mortgage assets). The Fixed-Income
Securities in which the portfolio invests may subject the portfolio to
greater volatility than its comparative index. This volatility may be
offset by the use of futures and swaps.
o Investments in securities rated below investment grade, generally
referred to as High Yield, high risk or junk bonds, carry a high degree
of credit risk and are considered speculative by the major rating
agencies;
o Investments in foreign securities involve certain special considerations
which are not typically associated with investing in U.S. companies. The
portfolio may also engage in foreign currency exchange transactions. See
Forwards, Futures & Options, and Swaps;
o Securities purchased on a When-Issued basis may decline or appreciate in
market value prior to their actual delivery to the portfolio;
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MAS Fund - 4 Terms in bold type are defined in the Prospectus Glossary
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o The portfolio may invest a portion of its assets in Derivatives including
Futures & Options. Futures contracts, options and options on futures
contracts entail certain costs and risks, including imperfect correlation
between the value of the securities held by the portfolio and the value
of the particular derivative instrument, and the risk that a portfolio
could not close out a futures or options position when it would be most
advantageous to do so; and
o The portfolio may invest in certain instruments such as Forwards, certain
types of Futures & Options, certain types of Mortgage Securities and
When-Issued Securities which require the portfolio to segregate some or
all of its cash or liquid securities to cover its obligations pursuant to
such instruments. As asset segregation reaches certain levels, the
portfolio may lose flexibility in managing its investments properly,
responding to shareholder redemption requests, or meeting other
obligations and may be forced to sell other securities that it wanted to
retain or to realize unintended gains or losses.
HOW TO INVEST: Institutional Class Shares of the portfolio are available to
clients of the Adviser with combined investments of $5,000,000 and Shareholder
Organizations who have a contractual arrangement with the Fund or the Fund's
Distributor, including institutions such as trusts, foundations or
broker-dealers purchasing for the accounts of others. Shares are offered
directly to investors without a sales commission at the net asset value of the
portfolio next determined after receipt of the order. Share purchases may be
made by sending investments directly to the Fund, subject to acceptance by the
Fund.
HOW TO REDEEM: Shares of the portfolio may be redeemed at any time at the net
asset value of the portfolio next determined after receipt of the redemption
request. The redemption price may be more or less than the purchase price. See
Redemption of Shares and Shareholder Services.
THE FUND'S INVESTMENT ADVISER: Miller Anderson & Sherrerd, LLP (the "Adviser")
is a Pennsylvania limited liability partnership founded in 1969, wholly owned
by indirect subsidiaries of Morgan Stanley Dean Witter & Co., and is located
at One Tower Bridge, West Conshohocken, PA 19428. The Adviser provides
investment counseling services to employee benefit plans, endowments,
foundations and other institutional investors, and as of June 30, 1998 had in
excess of $67 billion in assets under management.
THE FUND'S DISTRIBUTOR: MAS Fund Distribution, Inc. (the "Distributor")
provides distribution services to the Fund.
YIELD AND TOTAL RETURN:
From time to time the portfolio advertises its yield and total return. Both
yield and total return figures are based on historical earnings and are not
intended to indicate future performance. The average annual total return
reflects changes in the price of the portfolio's shares and assumes that any
income dividends and/or capital gain distributions made by the portfolio
during the period were reinvested in additional shares of the portfolio.
Figures will be given for one-, five- and ten-year periods ending with the
most recent calendar quarter-end (if applicable), and may be given for other
periods as well (such as from commencement of the portfolio's operations).
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Terms in bold type are defined in the Prospectus Glossary MAS Fund - 5
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The yield of the portfolio is computed by dividing the net investment income
per share (using the average number of shares entitled to receive dividends)
earned during a 30-day period by the closing price per share on the last day
of the period. For the purpose of determining net investment income, the
calculation includes as expenses of the portfolio all recurring fees and any
non recurring charges for the period stated.
The performance of the portfolio may be compared to data prepared by
independent services which monitor the performance of investment companies,
data reported in financial and industry publications, returns of other
investment advisers and mutual funds, and various indices as further described
in the Statement of Additional Information.
The Annual Report to Shareholders of the Fund for the Fund's most recent
fiscal year-end contains additional performance information that includes
comparisons with appropriate indices. The Annual Report is available without
charge upon request by writing to the Fund or calling the Client Services
Group at the telephone number shown on the front cover of this Prospectus.
GENERAL INFORMATION
Suitability: The portfolio is designed for long-term investors who can accept
the risks entailed in investing in the stock and bond markets, and is not
meant to provide a vehicle for playing short-term swings in the market. The
portfolio is designed principally for the investments of tax-exempt fiduciary
investors who are entrusted with the responsibility of investing assets held
for the benefit of others. Since such investors are not subject to Federal
income taxes, securities transactions for the portfolio will not be influenced
by the different tax treatment of capital gains and dividend income under the
Internal Revenue Code.
Securities Lending: The portfolio may lend its securities to qualified
brokers, dealers, banks and other financial institutions for the purpose of
realizing additional income. Loans of securities will be collateralized by
cash, letters of credit, or securities issued or guaranteed by the U.S.
Government or its agencies. The collateral will equal at least 100% of the
current market value of the loaned securities. In addition, the portfolio will
not loan its portfolio securities to the extent that greater than one-third of
its total assets, at fair market value, would be committed to loans at that
time.
Illiquid Securities/Restricted Securities: The portfolio may invest up to 15%
of its net assets in securities that are illiquid by virtue of the absence of
a readily available market, or because of legal or contractual restrictions on
resale. This policy does not limit the acquisition of (i) restricted
securities eligible for resale to qualified institutional buyers pursuant to
Rule 144A under the Securities Act of 1933 or (ii) commercial paper issued
pursuant to Section 4(2) under the Securities Act of 1933, that are determined
to be liquid in accordance with guidelines established by the Fund's Board of
Trustees.
Turnover: The Adviser manages the portfolio generally without regard to
restrictions on annual turnover. In general, the portfolio will not trade for
short-term profits, but when circumstances warrant, investments may be sold
without regard to the length of time held.
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MAS Fund - 6 Terms in bold type are defined in the Prospectus Glossary
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6
The portfolio's annual turnover rate is expected not to exceed 200%. This high
rate of annual turnover necessarily results in correspondingly heavier
portfolio trading costs which are paid by the portfolio as well as possible
tax consequences (e.g., higher level of realized gains). Trading in
Fixed-Income Securities does not generally involve the payment of brokerage
commissions, but does involve indirect transaction costs. In addition to
portfolio trading costs, higher rates of annual turnover may result in the
realization of capital gains. To the extent net short-term capital gains are
realized, any distributions resulting from such gains are considered ordinary
income for federal income tax purposes.
Cash Equivalents/Temporary Defensive Investing: Although the portfolio intends
to remain substantially fully invested, a small percentage of the portfolio's
assets is generally held in the form of Cash Equivalents in order to meet
redemption requests and otherwise manage the daily affairs of the portfolio.
In addition, the portfolio may, when the Adviser deems that market conditions
are such that a temporary defensive approach is desirable, invest in Cash
Equivalents without limit. In addition, the Adviser may, for temporary
defensive purposes, increase or decrease the average weighted maturity or
duration of the portfolio without regard to the portfolio's usual average
weighted maturity.
Concentration: Concentration is defined as investment of 25% or more of a
portfolio's total assets in the securities of issuers operating in any one
industry. The portfolio will not concentrate investments in any one industry.
Investment Limitations: The portfolio is subject to certain limitations
designed to reduce its exposure to specific situations. Some of these
limitations are:
(a) with respect to 75% of its assets, the portfolio will not purchase
securities of any issuer if, as a result, more than 5% of the portfolio's
total assets taken at market value would be invested in the securities of any
single issuer except that this restriction does not apply to securities issued
or guaranteed by the U.S. Government or its agencies or instrumentalities; and
(b) with respect to 75% of its assets, the portfolio will not purchase a
security if, as a result, the portfolio would hold more than 10% of the
outstanding voting securities of any issuer.
Limitations (a) and (b) and certain other limitations described in the
Statement of Additional Information are fundamental and may be changed only
with the approval of the holders of a majority of the shares of the portfolio.
Other investment limitations described here and in the Statement of Additional
Information are not fundamental policies, meaning that the Board of Trustees
may change them without shareholder approval. If a percentage limitation on
investment or utilization of assets as set forth in this prospectus or the
Statement of Additional Information is adhered to at the time an investment is
made, a later change in percentage resulting from changes in the value or
total cost of the portfolio's assets will not be considered a violation of the
restriction, and the sale of securities will not be required.
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Terms in bold type are defined in the Prospectus Glossary MAS Fund - 7
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Targeted Duration Portfolio
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Objective: To achieve above-average total return consistent with
reasonable risk, by investing in a diversified
portfolio representing a broad range of fixed-income
securities. The portfolio's average duration will
ordinarily be less than two years.
Approach: The portfolio intends to approximate the duration of
the Merrill Lynch 1-3 Year Government Bond Index by
investing in a wide variety of Fixed-Income
Securities in all market sectors, as well as futures
and swaps. The Adviser actively manages the overall
duration structure of the portfolio in order to
control interest rate risk more effectively. The
Adviser will use futures and swaps to accomplish this
goal, rather than limiting the maturity of individual
securities within the portfolio. Duration is a
present-value measure of the price sensitivity of
debt securities. Lower average duration corresponds
to lower price volatility relative to interest rate
changes.
Policies: Generally at least 65% invested in Fixed-Income
Securities
May invest greater than 50% in Mortgage Securities
Derivatives may be used to pursue portfolio strategy
Quality Specifications: 80% Investment Grade Securities
Up to 20% High Yield
Duration: Average duration will approximate that of the Merrill
Lynch 1-3 Year Government Bond Index (currently 1.7
years.)
Allowable Investments: Agencies Floaters Investment Companies Structured Notes
Asset-Backeds Foreign Bonds Loan Participations Swaps
Brady Bonds Foreign Currency Mortgage Securities U.S. Governments
Cash Equivalents Forwards Municipals When-Issued Securities
CMOs Futures & Options Preferred Stock Yankees
Convertibles High Yield Repurchase Agreements Zero Coupons
Corporates Inverse Floaters SMBS
Comparative Index: Merrill Lynch 1-3 Year Government Bond Index
Strategies: Maturity and Duration Management
Value Investing
Mortgage Investing
High Yield Investing
Foreign Investing
Foreign Fixed Income Investing
Portfolio
Management Team: Scott F. Richard and Michele A. Kreisler
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MAS Fund - 8 Terms in bold type are defined in the Prospectus Glossary
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PROSPECTUS GLOSSARY
CHARACTERISTICS AND RISKS OF STRATEGIES AND INVESTMENTS
STRATEGIES
Foreign Fixed Income Investing: The Adviser invests in Foreign Bonds and other
Fixed-Income Securities denominated in foreign currencies, where, in the
opinion of the Adviser, the combination of current yield and currency value
offer attractive expected returns. When the total return opportunities in a
foreign bond market appear attractive in local currency terms, but where in
the Adviser's judgment unacceptable currency risk exists, currency Futures &
Options, Forwards and Swaps may be used to hedge the currency risk.
Foreign Investing: Investors should recognize that investing in Foreign Bonds
involves certain special considerations which are not typically associated
with investing in domestic securities.
As non-U.S. companies are not generally subject to uniform accounting,
auditing and financial reporting standards and practices comparable to those
applicable to U.S. companies, there may be less publicly available information
about certain foreign securities than about U.S. securities. Foreign Bonds may
be less liquid and more volatile than securities of comparable U.S. companies.
There is generally less government supervision and regulation of stock
exchanges, brokers and listed companies than in the U.S. With respect to
certain foreign countries, there is the possibility of expropriation or
confiscatory taxation, political or social instability, or diplomatic
developments which could affect U.S. investments in those countries.
Additionally, there may be difficulty in obtaining and enforcing judgments
against foreign issuers.
Since Foreign Bonds may be denominated in foreign currencies, and since the
portfolio may temporarily hold uninvested reserves in bank deposits of foreign
currencies prior to reinvestment or conversion to U.S. dollars, the portfolio
may be affected favorably or unfavorably by changes in currency rates and in
exchange control regulations, and may incur costs in connection with
conversions between various currencies.
Although the portfolio will endeavor to achieve the most favorable execution
costs in its portfolio transactions in foreign securities, fixed commissions
on many foreign stock exchanges are generally higher than negotiated
commissions on U.S. exchanges. In addition, it is expected that the expenses
for custodial arrangements of the portfolio's foreign securities will be
greater than the expenses for the custodial arrangements for handling U.S.
securities of equal value. Certain foreign governments levy withholding taxes
against dividend and interest income. Although in some countries a portion of
these taxes is recoverable, the non-recovered portion of foreign withholding
taxes will reduce the income the portfolio receives from the companies
comprising the portfolio's investments.
High Yield Investing: Involves investing in High Yield securities based on the
Adviser's analysis of economic and industry trends and individual security
characteristics. The Adviser conducts credit analysis for each security
considered for investment to evaluate its attractiveness relative to its risk.
A high level of diversification is also maintained to limit credit exposure to
individual issuers.
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Terms in bold type are defined in the Prospectus Glossary MAS Fund - 9
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To the extent the portfolio invests in High Yield securities it will be
exposed to a substantial degree of credit risk. Lower-rated bonds are
considered speculative by traditional investment standards. High Yield
securities may be issued as a consequence of corporate restructuring or
similar events. Also, High Yield securities are often issued by smaller, less
credit worthy companies, or by highly leveraged (indebted) firms, which are
generally less able than more established or less leveraged firms to make
scheduled payments of interest and principal. The risks posed by securities
issued under such circumstances are substantial.
The market for High Yield securities is still relatively new. Because of this,
a long-term track record for bond default rates does not exist. In addition,
the secondary market for high yield securities is generally less liquid than
that for investment grade corporate securities. In periods of reduced market
liquidity, high yield bond prices may become more volatile, and both the high
yield market and the portfolio may experience sudden and substantial price
declines. This lower liquidity might have an effect on the portfolio's ability
to value or dispose of such securities. Also, there may be significant
disparities in the prices quoted for high yield securities by various dealers.
Under such conditions, the portfolio may find it difficult to value its
securities accurately. The portfolio may also be forced to sell securities at
a significant loss in order to meet shareholder redemptions. These factors add
to the risks associated with investing in High Yield securities.
High yield bonds may also present risks based on payment expectations. For
example, high yield bonds may contain redemption or call provisions. If an
issuer exercises these provisions in a declining interest rate market, the
portfolio would have to replace the security with a lower yielding security,
resulting in a decreased return for investors.
Certain types of high yield bonds are non-income paying securities. For
example, Zero Coupons pay interest only at maturity and payment-in-kind bonds
pay interest in the form of additional securities. Payment in the form of
additional securities, or interest income recognized through discount
accretion, will, however, be treated as ordinary income which will be
distributed to shareholders even though the portfolio does not receive
periodic cash flow from these investments.
Maturity and Duration Management: The Adviser actively manages the duration
structure of the portfolio in an attempt to approximate the duration of the
Merrill Lynch 1-3 Year Government Bond Index. The Adviser uses futures and
swaps to manage the duration of the overall portfolio as a more effective way
to control interest rate risk than limiting the maturity of individual
securities within the portfolio.
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MAS Fund - 10 Terms in bold type are defined in the Prospectus Glossary
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About Maturity and Duration: Most debt obligations provide interest (coupon)
payments in addition to a final (par) payment at maturity. Some obligations
also have call provisions. Depending on the relative magnitude of these
payments and the nature of the call provisions, the market values of debt
obligations may respond differently to changes in the level and structure of
interest rates. Traditionally, a debt security's term-to-maturity has been
used as a proxy for the sensitivity of the security's price to changes in
interest rates (which is the interest rate risk or volatility of the
security). However, term-to-maturity measures only the time until a debt
security provides its final payment, taking no account of the pattern of the
security's payments prior to maturity.
Duration is a measure of the expected life of a Fixed-Income Security that was
developed as a more precise alternative to the concept of term-to-maturity.
Duration incorporates a bond's yield, coupon interest payments, final maturity
and call features into one measure. Duration is one of the fundamental tools
used by the Adviser in the selection of Fixed-Income Securities. Duration is a
measure of the expected life of a Fixed-Income Security on a present value
basis. Duration takes the length of the time intervals between the present
time and the time that the interest and principal payments are scheduled or,
in the case of a callable bond, expected to be received, and weights them by
the present values of the cash to be received at each future point in time.
For any Fixed-Income Security with interest payments occurring prior to the
payment of principal, duration is always less than maturity. In general, all
other factors being the same, the lower the stated or coupon rate of interest
of a fixed-income security, the longer the duration of the security;
conversely, the higher the stated or coupon rate of interest of a Fixed-Income
Security, the shorter the duration of the security.
There are some situations where even the standard duration calculation does
not properly reflect the interest rate exposure of a security. For example,
floating and variable rate securities often have final maturities of ten or
more years; however, their interest rate exposure corresponds to the frequency
of the coupon reset. Another example where the interest rate exposure is not
properly captured by duration is the case of mortgage pass-through securities.
The stated final maturity of such securities is generally 30 years, but
current prepayment rates are more critical in determining the securities'
interest rate exposure. In these and other similar situations, the Adviser
will use sophisticated analytical techniques that incorporate the economic
life of a security into the determination of its interest rate exposure.
Mortgage Investing: At times it is anticipated that greater than 50% of the
portfolio's assets may be invested in mortgage-related securities. These
include Mortgage Securities which represent interests in pools of mortgage
loans made by lenders such as commercial banks, savings and loan associations,
mortgage bankers and others. The pools are assembled by various organizations,
including the Government National Mortgage Association (GNMA), Federal Home
Loan Mortgage Corporation (FHLMC), Fannie Mae, other government agencies, and
private issuers. It is expected that the portfolio's primary emphasis will be
in Mortgage Securities issued by the various government-related organizations.
However, the portfolio may invest, without limit, in Mortgage Securities
issued by private issuers when the Adviser deems that the quality of the
investment, the quality of the issuer, and market conditions warrant such
investments. Securities issued by private issuers will be rated investment
grade by Moody's or Standard & Poor's or be deemed by the Adviser to be of
comparable investment quality.
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Terms in bold type are defined in the Prospectus Glossary MAS Fund - 11
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Value Investing: One of two primary components of the Adviser's fixed-income
strategy is value investing, whereby the Adviser seeks to identify undervalued
sectors and securities through analysis of credit quality, option
characteristics and liquidity. Quantitative models are used in conjunction
with judgment and experience to evaluate and select securities with embedded
put or call options which are attractive on a risk- and option-adjusted basis.
Successful value investing will permit the portfolio to benefit from the price
appreciation of individual securities during periods when interest rates are
unchanged. See Maturity and Duration Management for a description of the other
key component of the Adviser's fixed-income investment strategy.
INVESTMENTS
The portfolio may invest in the securities defined below in accordance with
its listing of Allowable Investments and any quality or policy constraints.
Agencies: are securities which are not guaranteed by the U.S. Government, but
which are issued, sponsored or guaranteed by a federal agency or federally
sponsored agency such as the Student Loan Marketing Association or any of
several other agencies.
Asset-Backeds: are securities collateralized by shorter term loans such as
automobile loans, home equity loans, computer leases, or credit card
receivables. The payments from the collateral are passed through to the
security holder. The collateral behind asset-backed securities tends to have
prepayment rates that do not vary with interest rates. In addition the
short-term nature of the loans reduces the impact of any change in prepayment
level. Due to amortization, the average life for these securities is also the
conventional proxy for maturity.
Possible Risks: Due to the possibility that prepayments (on automobile loans
and other collateral) will alter the cash flow on asset-backed securities, it
is not possible to determine in advance the actual final maturity date or
average life. Faster prepayment will shorten the average life and slower
prepayments will lengthen it. However, it is possible to determine what the
range of that movement could be and to calculate the effect that it will have
on the price of the security. In selecting these securities, the Adviser will
look for those securities that offer a higher yield to compensate for any
variation in average maturity.
Brady Bonds: are debt obligations which are created through the exchange of
existing commercial bank loans to foreign entities for new obligations in
connection with debt restructuring under a plan introduced by former U.S.
Secretary of the Treasury, Nicholas F. Brady (the Brady Plan). Brady Bonds
have been issued fairly recently, and, accordingly, do not have a long payment
history. They may be collateralized or uncollateralized and issued in various
currencies (although most are dollar-denominated) and they are actively traded
in the over-the-counter secondary market. For further information on these
securities, see the Statement of Additional Information. The portfolio will
only invest in Brady Bonds consistent with quality specifications.
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MAS Fund - 12 Terms in bold type are defined in the Prospectus Glossary
<PAGE>
Cash Equivalents: are short-term fixed-income instruments comprising:
(1) Time deposits, certificates of deposit (including marketable variable rate
certificates of deposit) and bankers' acceptances issued by a commercial bank
or savings and loan association. Time deposits are non-negotiable deposits
maintained in a banking institution for a specified period of time at a stated
interest rate. Certificates of deposit are negotiable short-term obligations
issued by commercial banks or savings and loan associations against funds
deposited in the issuing institution. Variable rate certificates of deposit
are certificates of deposit on which the interest rate is periodically
adjusted prior to their stated maturity based upon a specified market rate. A
bankers' acceptance is a time draft drawn on a commercial bank by a borrower
usually in connection with an international commercial transaction (to finance
the import, export, transfer or storage of goods).
The portfolio may invest in obligations of U.S. banks, and in foreign branches
of U.S. banks (Eurodollars) and U.S. branches of foreign banks (Yankee
dollars). Euro and Yankee dollar investments will involve some of the same
risks of investing in international securities that are discussed in the
Foreign Investing section of this Prospectus.
The portfolio will not invest in any security issued by a commercial bank
unless (i) the bank has total assets of at least $1 billion, or the equivalent
in other currencies, or, in the case of domestic banks which do not have total
assets of at least $1 billion, the aggregate investment made in any one such
bank is limited to $100,000 and the principal amount of such investment is
insured in full by the Federal Deposit Insurance Corporation, (ii) in the case
of U.S. banks, it is a member of the Federal Deposit Insurance Corporation,
and (iii) in the case of foreign branches of U.S. banks, the security is
deemed by the Adviser to be of an investment quality comparable with other
debt securities which may be purchased by the portfolio;
(2) The portfolio may invest in commercial paper rated at time of purchase by
one or more Nationally Recognized Statistical Rating Organizations ("NRSRO")
in one of their two highest categories, (e.g., A-l or A-2 by Standard & Poor's
or Prime 1 or Prime 2 by Moody's), or, if not rated, issued by a corporation
having an outstanding unsecured debt issue rated high-grade by a NRSRO (e.g., A
or better by Moody's, Standard & Poor's or Fitch);
(3) Short-term corporate obligations rated high-grade at the time of purchase
by a NRSRO (e.g., A or better by Moody's, Standard & Poor's or Fitch);
4) U.S. Government obligations including bills, notes, bonds and other debt
securities issued by the U.S. Treasury. These are direct obligations of the
U.S. Government and differ mainly in interest rates, maturities and dates of
issue;
(5) Government Agency securities issued or guaranteed by U.S. Government
sponsored instrumentalities and Federal agencies. These include securities
issued by the Federal Home Loan Banks, Federal Land Bank, Farmers Home
Administration, Farm Credit Banks, Federal Intermediate Credit Bank, Fannie
Mae, Federal Financing Bank, the Tennessee Valley Authority, and others; and
(6) Repurchase Agreements collateralized by securities listed above.
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Terms in bold type are defined in the Prospectus Glossary MAS Fund - 13
<PAGE>
CMOs--Collateralized Mortgage Obligations: are Derivatives which are
collateralized by mortgage pass-through securities. Cash flows from the
mortgage pass-through securities are allocated to various tranches (a
"tranche" is essentially a separate security) in a predetermined, specified
order. Each tranche has a stated maturity - the latest date by which the
tranche can be completely repaid, assuming no prepayments - and has an average
life - the average of the time to receipt of a principal payment weighted by
the size of the principal payment. The average life is typically used as a
proxy for maturity because the debt is amortized (repaid a portion at a time),
rather than being paid off entirely at maturity, as would be the case in a
straight debt instrument.
Possible Risks: Due to the possibility that prepayments (on home mortgages and
other collateral) will alter the cash flow on CMOs, it is not possible to
determine in advance the actual final maturity date or average life. Faster
prepayment will shorten the average life and slower prepayments will lengthen
it. However, it is possible to determine what the range of that movement could
be and to calculate the effect that it will have on the price of the security.
In selecting these securities, the Adviser will look for those securities that
offer a higher yield to compensate for any variation in average maturity.
Like bonds in general, Mortgage Securities will generally decline in price
when interest rates rise. Rising interest rates also tend to discourage
refinancings of home mortgages with the result that the average life of
Mortgage Securities held by a portfolio may be lengthened. This extension of
average life causes the market price of the securities to decrease further
than if their average lives were fixed. In part to compensate for these risks,
mortgages will generally offer higher yields than comparable bonds. However,
when interest rates fall, mortgages may not enjoy as large a gain in market
value due to prepayment risk because additional mortgage prepayments must be
reinvested at lower interest rates.
Convertibles: are convertible bonds or shares of convertible Preferred Stock
which may be exchanged for a fixed number of shares of common stock at the
purchaser's option.
Corporates--Corporate bonds: are debt instruments issued by private
corporations. Bondholders, as creditors, have a prior legal claim over common
and preferred stockholders of the corporation as to both income and assets for
the principal and interest due to the bondholder. The portfolio will buy
Corporates subject to any quality constraints. If a security held by the
portfolio is down-graded, the portfolio may retain the security if the Adviser
deems retention of the security to be in the best interests of the portfolio.
Derivatives: A financial instrument whose value and performance are based on
the value and performance of another security or financial instrument. The
Adviser will use derivatives only in circumstances where they offer the most
economic means of improving the risk/reward profile of the portfolio. The
Adviser will not use derivatives to increase portfolio risk above the level
that could be achieved in the portfolio using only traditional investment
securities. In addition, the Adviser will not use derivatives to acquire
exposure to changes in the value of assets or indexes of assets that are not
listed in the applicable Allowable Investments for the portfolio. Any
applicable limitations are described under each investment definition. The
portfolio may enter into over-the-counter Derivatives transactions with
counterparties approved by the Adviser in accordance with guidelines
established by the Board of Trustees. These guidelines provide for a minimum
credit rating for each counterparty and various credit enhancement techniques
(for example, collateralization of amounts due from counterparties) to limit
exposure to counterparties with ratings below
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MAS Fund - 14 Terms in bold type are defined in the Prospectus Glossary
<PAGE>
AA. Derivatives include, but are not limited to, CMOs, Forwards, Futures and
Options, SMBS, Structured Notes and Swaps.
Fixed-Income Securities: Commonly include but are not limited to U.S.
Governments, Zero Coupons, Agencies, Corporates, High Yield, Mortgage
Securities, SMBS, CMOs, Asset-Backeds, Convertibles, Brady Bonds, Floaters,
Inverse Floaters, Cash Equivalents, Repurchase Agreements, Preferred Stock,
and Foreign Bonds.
Floaters--Floating and Variable Rate Obligations: are debt obligations with a
floating or variable rate of interest, i.e. the rate of interest varies with
changes in specified market rates or indices, such as the prime rate, or at
specified intervals. Certain floating or variable rate obligations may carry a
demand feature that permits the holder to tender them back to the issuer of
the underlying instrument, or to a third party, at par value prior to
maturity. When the demand feature of certain floating or variable rate
obligations represents an obligation of a foreign entity, the demand feature
will be subject to certain risks discussed under Foreign Investing.
Foreign Bonds: are Fixed Income Securities denominated in foreign currency and
issued and traded primarily outside of the U.S., including: (1) obligations
issued or guaranteed by foreign national governments, their agencies,
instrumentalities, or political subdivisions; (2) debt securities issued,
guaranteed or sponsored by supranational organizations established or
supported by several national governments, including the World Bank, the
European Community, the Asian Development Bank and others; (3) non-government
foreign corporate debt securities; and (4) foreign Mortgage Securities and
various other mortgages and asset-backed securities.
Foreign Currency: In connection with the portfolio's investment in foreign
securities, the portfolio may transact security purchases and sales in foreign
currencies. The portfolio may hold foreign currency or purchase or sell
currencies on a forward basis (see Forwards).
Forwards--Forward Foreign Currency Exchange Contracts: are Derivatives which
are used to protect against uncertainty in the level of future foreign
exchange rates. A forward foreign currency exchange contract is an obligation
to purchase or sell a specific currency at a future date, which may be any
fixed number of days from the date of the contract agreed upon by the parties,
at a price set at the time of the contract. Such contracts do not eliminate
fluctuations caused by changes in the local currency prices of the securities,
but rather, they establish an exchange rate at a future date. Also, although
such contracts can minimize the risk of loss due to a decline in the value of
the hedged currency, at the same time they limit any potential gain that might
be realized.
The portfolio may use currency exchange contracts in the normal course of
business to lock in an exchange rate in connection with purchases and sales of
securities denominated in foreign currencies (transaction hedge) or to lock in
the U.S. dollar value of portfolio positions (position hedge). In addition,
the portfolio may cross hedge currencies by entering into a transaction to
purchase or sell one or more currencies that are expected to decline in value
relative to other currencies to which the portfolio has or expects to have
portfolio exposure. The portfolio may also engage in proxy hedging which is
defined as entering into positions in one currency to hedge investments
denominated in another currency, where the two currencies are economically
linked. The portfolio's entry into forward contracts, as
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Terms in bold type are defined in the Prospectus Glossary MAS Fund - 15
<PAGE>
well as any use of cross or proxy hedging techniques will generally require
the portfolio to hold liquid securities or cash equal to the portfolio's
obligations in a segregated account throughout the duration of the contract.
The portfolio may also combine forward contracts with investments in
securities denominated in other currencies in order to achieve desired credit
and currency exposures. Such combinations are generally referred to as
synthetic securities. For example, in lieu of purchasing a foreign bond, the
portfolio may purchase a U.S. dollar-denominated security and at the same time
enter into a forward contract to exchange U.S. dollars for the contract's
underlying currency at a future date. By matching the amount of U.S. dollars
to be exchanged with the anticipated value of the U.S. dollar-denominated
security, the portfolio may be able to lock in the foreign currency value of
the security and adopt a synthetic investment position reflecting the credit
quality of the U.S. dollar-denominated security.
There is a risk in adopting a transaction hedge or position hedge to the
extent that the value of a security denominated in foreign currency is not
exactly matched with the portfolio's obligation under the forward contract. On
the date of maturity, the portfolio may be exposed to some risk of loss from
fluctuations in that currency. Although the Adviser will attempt to hold such
mismatching to a minimum, there can be no assurance that the Adviser will be
able to do so. For proxy hedges, cross hedges or a synthetic position, there
is an additional risk in that these transactions create residual foreign
currency exposure. When the portfolio enters into a forward contract for
purposes of creating a position hedge, transaction hedge, cross hedge or a
synthetic security, it will generally be required to hold liquid securities or
cash in a segregated account with a daily value at least equal to its
obligation under the forward contract.
Futures & Options--Futures Contracts, Options on Futures Contracts and
Options: are Derivatives. Futures contracts provide for the sale by one party
and purchase by another party of a specified amount of a specific security, at
a specified future time and price. An option is a legal contract that gives
the holder the right to buy or sell a specified amount of the underlying
security or futures contract at a fixed or determinable price upon the
exercise of the option. A call option conveys the right to buy and a put
option conveys the right to sell a specified quantity of the underlying
security.
The portfolio may enter into futures contracts and options thereon for both
hedging and non-hedging purposes, provided that not more than 5% of the
portfolio's total assets at the time of entering the transaction are required
as margin and option premiums to secure obligations under such contracts other
than those relating to bona fide hedging activities. It will maintain assets
sufficient to meet its obligations under such contracts in a segregated account
with the custodian bank or will otherwise comply with the Securities and
Exchange Commission's ("SEC's") position on asset coverage.
Possible Risks: The primary risks associated with the use of Futures and
Options are (i) imperfect correlation between the change in market value of
the securities held by the portfolio and the prices of futures and options
relating to the stocks, bonds or futures contracts purchased or sold by the
portfolio; (ii) possible lack of a liquid secondary market for a futures
contract and the resulting inability to close a futures position which could
have an adverse impact on the portfolio's ability to execute futures and
options strategies; (iii) potentially unlimited losses with respect to certain
futures contracts; and (iv) inaccurate predictions of the direction of stock
prices, interest rates and other economic factors, which determine the extent
of gains and losses from options and futures. Additional risks associated
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MAS Fund - 16 Terms in bold type are defined in the Prospectus Glossary
<PAGE>
with options transactions are (i) the risk that an option will expire
worthless; (ii) the risk that the issuer of an over-the-counter option will be
unable to fulfill its obligation to the portfolio due to bankruptcy or related
circumstances; (iii) the risk that options may exhibit greater short-term
price volatility than the underlying security; and (iv) the risk that the
portfolio may be forced to forego participation in the appreciation of the
value of underlying securities, futures contracts or currency due to the
writing of a call option.
High Yield: High yield securities are generally considered to be Corporates,
Preferred Stocks, and Convertibles rated Ba through C by Moody's or BB through
D by Standard & Poor's, and unrated securities considered to be of equivalent
quality. Securities rated less than Baa by Moody's or BBB by Standard & Poor's
are classified as non-investment grade securities and are commonly referred to
as junk bonds or high yield, high risk securities. Such securities carry a
high degree of risk and are considered speculative by the major credit rating
agencies. The following are excerpts from the Moody's and Standard & Poor's
definitions for speculative-grade debt obligations:
Moody's: Ba-rated bonds have "speculative elements" so their future
"cannot be considered assured," and protection of principal and interest
is "moderate" and "not well safeguarded during both good and bad times in
the future." B-rated bonds "lack characteristics of a desirable
investment" and the assurance of interest or principal payments "may be
small." Caa-rated bonds are "of poor standing" and "may be in default" or
may have "elements of danger with respect to principal or interest."
Ca-rated bonds represent obligations which are speculative in a high
degree. Such issues are often in default or have other marked
shortcomings. C-rated bonds are the "lowest rated" class of bonds, and
issues so rated can be regarded as having "extremely poor prospects" of
ever attaining any real investment standing.
Standard & Poor's: BB-rated bonds have "less near-term vulnerability to
default" than B- or CCC-rated securities but face "major ongoing
uncertainties . . . which may lead to inadequate capacity" to pay
interest or principal. B-rated bonds have a "greater vulnerability to
default than BB-rated bonds and the ability to pay interest or principal
will likely be impaired by adverse business conditions." CCC-rated bonds
have a currently identifiable "vulnerability to default" and, without
favorable business conditions, will be "unable to repay interest and
principal." The rating C is reserved for income bonds on which "no
interest is being paid." Debt rated D is in "default", and "payment of
interest and/or repayment of principal is in arrears."
While these securities offer high yields, they also normally carry with them a
greater degree of risk than securities with higher ratings. Lower-rated bonds
are considered speculative by traditional investment standards. High yield
securities may be issued as a consequence of corporate restructuring or
similar events. Also, high yield securities are often issued by smaller, less
credit worthy companies, or by highly leveraged (indebted) firms, which are
generally less able than more established or less leveraged firms to make
scheduled payments of interest and principal. The price movement of these
securities is influenced less by changes in interest rates and more by the
financial and business position of the issuing corporation when compared to
investment grade bonds.
The risks posed by securities issued under such circumstances are substantial.
If a security held by the portfolio is down-graded, the portfolio may retain
the security.
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Terms in bold type are defined in the Prospectus Glossary MAS Fund - 17
<PAGE>
Inverse Floaters--Inverse Floating Rate Obligations: are Fixed-Income
Securities, which have coupon rates that vary inversely at a multiple of a
designated floating rate, such as LIBOR (London Inter-Bank Offered Rate). Any
rise in the reference rate of an Inverse Floater (as a consequence of an
increase in interest rates) causes a drop in the coupon rate while any drop in
the reference rate of an Inverse Floater causes an increase in the coupon
rate. Inverse Floaters may exhibit substantially greater price volatility than
fixed rate obligations having similar credit quality, redemption provisions
and maturity, and Inverse Floater CMOs exhibit greater price volatility than
the majority of mortgage pass-through securities or CMOs. In addition, some
Inverse Floater CMOs exhibit extreme sensitivity to changes in prepayments. As
a result, the yield to maturity of an Inverse Floater CMO is sensitive not
only to changes in interest rates but also to changes in prepayment rates on
the related underlying mortgage assets.
Investment Companies: The portfolio is permitted to invest in shares of other
open-end or closed-end investment companies. The 1940 Act generally prohibits
the portfolio from acquiring more than 3% of the outstanding voting shares of
an investment company and limits such investments to no more than 5% of the
portfolio's total assets in any one investment company and no more than 10% in
any combination of investment companies. The 1940 Act also prohibits the
portfolio from acquiring in the aggregate more than 10% of the outstanding
voting shares of any registered closed-end investment company.
To the extent the portfolio invests a portion of its assets in Investment
Companies, those assets will be subject to the expenses of the investment
company as well as to the expenses of the portfolio itself. The portfolio may
not purchase shares of any affiliated investment company except as permitted
by SEC rule or order.
Investment Grade Securities: are those (a) rated by one or more nationally
recognized statistical rating organization (NRSRO) in one of the four highest
rating categories at the time of purchase (e.g. AAA, AA, A or BBB by Standard
& Poor's Corporation (Standard & Poor's) or Fitch Investors Service, Inc.,
(Fitch) or Aaa, Aa, A or Baa by Moody's Investors Service, Inc. (Moody's));
(b) guaranteed by the U.S. Government or a private organization; or (c)
considered by the Adviser to be investment grade quality. Securities rated BBB
or Baa represent the lowest of four levels of Investment Grade Securities and
are regarded as borderline between definitely sound obligations and those in
which the speculative element begins to predominate. Mortgage Securities,
including mortgage pass-throughs and CMOs, deemed investment grade by the
Adviser, will either carry a guarantee from an agency of the U.S. Government
or a private issuer of the timely payment of principal and interest (such
guarantees do not extend to the market value of such securities or the net
asset value per share of the portfolio) or, in the case of unrated securities,
be sufficiently seasoned that they are considered by the Adviser to be
investment grade quality. The Adviser may retain securities if their ratings
fall below investment grade if it deems retention of the security to be in the
best interests of the portfolio. Any portfolio permitted to hold Investment
Grade Securities may hold unrated securities if the Adviser considers the
risks involved in owning that security to be equivalent to the risks involved
in holding an Investment Grade Security.
Loan Participations: are loans or other direct debt instruments which are
interests in amounts owed by a corporate, governmental or other borrower to
another party. They may represent amounts owed to lenders or lending
syndicates, to suppliers of goods or services (trade claims or other
receivables), or to other parties. Direct debt instruments involve the risk of
loss in case of default or insolvency of the borrower. Direct debt instruments
may offer less legal protection to the portfolio in the event of fraud or
misrepresentation. In addition, loan participations involve a risk of
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MAS Fund - 18 Terms in bold type are defined in the Prospectus Glossary
<PAGE>
insolvency of the lending bank or other financial intermediary. Direct debt
instruments may also include standby financing commitments that obligate the
investing portfolio to supply additional cash to the borrower on demand.
Mortgage Securities--Mortgage-backed securities represent an ownership
interest in a pool of residential and commercial mortgage loans. Generally,
these securities are designed to provide monthly payments of interest and
principal to the investor. The mortgagee's monthly payments to his/her lending
institution are passed through to investors such as the portfolio. Most
issuers or poolers provide guarantees of payments, regardless of whether the
mortgagor actually makes the payment. The guarantees made by issuers or
poolers are supported by various forms of credit, collateral, guarantees or
insurance, including individual loan, title, pool and hazard insurance
purchased by the issuer. The pools are assembled by various governmental,
government-related and private organizations. Portfolios may invest in
securities issued or guaranteed by the Government National Mortgage
Association (GNMA), Federal Home Loan Mortgage Corporation (FHLMC), Fannie
Mae, private issuers and other government agencies. There can be no assurance
that the private issuers can meet their obligations under the policies.
Mortgage Securities issued by non-agency issuers, whether or not such
securities are subject to guarantees, may entail greater risk. If there is no
guarantee provided by the issuer, mortgage-backed securities purchased by the
portfolio will be those which at time of purchase are rated investment grade
by one or more NRSRO, or, if unrated, are deemed by the Adviser to be of
investment grade quality.
There are two methods of trading Mortgage Securities. A specified pool
transaction is a trade in which the pool number of the security to be
delivered on the settlement date is known at the time the trade is made. This
is in contrast with the typical Mortgage Security transaction, called a TBA
(to be announced) transaction, in which the type of Mortgage Securities to be
delivered is specified at the time of trade but the actual pool numbers of the
securities that will be delivered are not known at the time of the trade. The
pool numbers of the pools to be delivered at settlement will be announced
shortly before settlement takes place. The terms of the TBA trade may be made
more specific if desired. Generally, agency pass-through Mortgage Securities
are traded on a TBA basis.
A mortgage-backed bond is a collateralized debt security issued by a thrift or
financial institution. The bondholder has a first priority perfected security
interest in collateral, usually consisting of agency mortgage pass-through
securities, although other assets, including U.S. Treasuries (including Zero
Coupon U.S. Treasuries), agencies, cash equivalent securities, whole loans and
corporate bonds, may qualify. The amount of collateral must be continuously
maintained at levels from 115% to 150% of the principal amount of the bonds
issued, depending on the specific issue structure and collateral type.
Possible Risks: Due to the possibility that prepayments on home mortgages will
alter cash flow on Mortgage Securities, it is not possible to determine in
advance the actual final maturity date or average life. Like bonds in general,
mortgage-backed securities will generally decline in price when interest rates
rise. Rising interest rates also tend to discourage refinancings of home
mortgages, with the result that the average life of Mortgage Securities held
by the portfolio may be lengthened. This extension of average life causes the
market price of the securities to decrease further than if their average lives
were fixed. However, when interest rates fall, mortgages may not enjoy as
large a gain in market value due to prepayment risk because additional
mortgage prepayments must be reinvested at lower interest rates. Faster
prepayment will shorten the average life and slower prepayments will lengthen
it. However, it is possible to determine what the range of that movement could
be and to calculate the effect that it will have on the
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Terms in bold type are defined in the Prospectus Glossary MAS Fund - 19
<PAGE>
price of the security. In selecting these securities, the Adviser will look
for those securities that offer a higher yield to compensate for any variation
in average maturity.
Municipals--Municipal Securities: are debt obligations issued by local, state
and regional governments that provide interest income which is exempt from
federal income taxes. Municipals include both municipal bonds (those
securities with maturities of five years or more) and municipal notes (those
with maturities of less than five years). Municipal bonds are issued for a
wide variety of reasons: to construct public facilities, such as airports,
highways, bridges, schools, hospitals, mass transportation, streets, water and
sewer works; to obtain funds for operating expenses; to refund outstanding
municipal obligations; and to loan funds to various public institutions and
facilities. Certain industrial development bonds are also considered municipal
bonds if their interest is exempt from federal income tax. Industrial
development bonds are issued by or on behalf of public authorities to obtain
funds for various privately-operated manufacturing facilities, housing, sports
arenas, convention centers, airports, mass transportation systems and water,
gas or sewage works. Industrial development bonds are ordinarily dependent on
the credit quality of a private user, not the public issuer.
General obligation municipal bonds are secured by the issuer's pledge of full
faith, credit and taxing power. Revenue or special tax bonds are payable from
the revenues derived from a particular facility or, in some cases, from a
special excise or other tax, but not from general tax revenue.
Municipal notes are issued to meet the short-term funding requirements of
local, regional and state governments. Municipal notes include bond
anticipation notes, revenue anticipation notes and tax and revenue
anticipation notes. These are short-term debt obligations issued by state and
local governments to aid cash flows while waiting for taxes or revenue to be
collected, at which time the debt is retired. Other types of municipal notes
in which the portfolio may invest are construction loan notes, short-term
discount notes, tax-exempt commercial paper, demand notes, and similar
instruments. Demand notes permit an investor (such as the portfolio) to demand
from the issuer payment of principal plus accrued interest upon a specified
number of days' notice. The portfolio may also purchase AMT bonds. AMT bonds
are tax-exempt private activity bonds issued after August 7, 1986, the
proceeds of which are directed, at least in part, to private, for-profit
organizations. While the income from AMT bonds is exempt from regular federal
income tax, it is a tax preference item in the calculation of the alternative
minimum tax. The alternative minimum tax is a special separate tax that
applies to a limited number of taxpayers who have certain adjustments to
income or tax preference items.
Preferred Stock: are non-voting ownership shares in a corporation which pay a
fixed or variable stream of dividends.
Repurchase Agreements: are transactions by which the portfolio purchases a
security and simultaneously commits to resell that security to the seller (a
bank or securities dealer) at an agreed upon price on an agreed upon date
(usually within seven days of purchase). The resale price reflects the
purchase price plus an agreed upon market rate of interest which is unrelated
to the coupon rate or date of maturity of the purchased security. Such
agreements permit the portfolio to keep all its assets at work while retaining
overnight flexibility in pursuit of investments of a longer term nature. The
Adviser will continually monitor the value of the underlying collateral to
ensure that its value, including accrued interest, always equals or exceeds
the repurchase price.
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MAS Fund - 20 Terms in bold type are defined in the Prospectus Glossary
<PAGE>
Pursuant to an order issued by the SEC, the Fund's
portfolios may pool their daily uninvested cash balances in order to invest in
Repurchase Agreements on a joint basis. By entering into Repurchase Agreements
on a joint basis, it is expected that the portfolios will incur lower
transaction costs and potentially obtain higher rates of interest on such
Repurchase Agreements. Each portfolio's participation in the income from
jointly purchased Repurchase Agreements will be based on that portfolio's
percentage share in the total Repurchase Agreement.
SMBS--Stripped Mortgage-Backed Securities: are Derivatives in the form of
multi-class mortgage securities. SMBS may be issued by agencies or
instrumentalities of the U.S. Government and private originators of, or
investors in, mortgage loans, including savings and loan associations,
mortgage banks, commercial banks, investment banks and special purpose
entities of the foregoing.
SMBS are usually structured with two classes that receive different
proportions of the interest and principal distributions on a pool of mortgage
assets. One type of SMBS will have one class receiving some of the interest
and most of the principal from the mortgage assets, while the other class will
receive most of the interest and the remainder of the principal. In some
cases, one class will receive all of the interest (the interest-only or IO
class), while the other class will receive all of the principal (the
principal-only or PO class). The yield to maturity on IOs and POs is extremely
sensitive to the rate of principal payments (including prepayments) on the
related underlying mortgage assets, and a rapid rate of principal payments may
have a material adverse effect on the portfolio's yield to maturity. If the
underlying mortgage assets experience greater than anticipated prepayments of
principal, the portfolio may fail to fully recoup its initial investment in
these securities, even if the security is in one of the highest rating
categories.
Although SMBS are purchased and sold by institutional investors through
several investment banking firms acting as brokers or dealers, these
securities were only recently developed. As a result, established trading
markets have not yet developed and, accordingly, certain of these securities
may be deemed illiquid and subject to the portfolio's limitations on
investment in illiquid securities.
Structured Notes: are Derivatives on which the amount of principal repayment
and or interest payments is based upon the movement of one or more factors.
These factors include, but are not limited to, currency exchange rates,
interest rates (such as the prime lending rate and LIBOR) and stock indices
such as the S&P 500 Index. In some cases, the impact of the movements of these
factors may increase or decrease through the use of multipliers or deflators.
The use of Structured Notes allows the portfolio to tailor its investments to
the specific risks and returns the Adviser wishes to accept while avoiding or
reducing certain other risks.
Swaps--Swap Contracts: are Derivatives in the form of a contract or other
similar instrument which is an agreement to exchange the return generated by
one instrument for the return generated by another instrument. The payment
streams are calculated by reference to a specified index and agreed upon
notional amount. The term specified index includes, but is not limited to,
currencies, fixed interest rates, prices and total return on interest rate
indices, fixed-income indices, stock indices and commodity indices (as well as
amounts derived from arithmetic operations on these indices). For example, the
portfolio may agree to swap the return generated by a fixed-income index for
the return generated by a second fixed-income index. The currency Swaps in
which the portfolio may enter will generally involve an agreement to pay
interest streams in one currency based on a specified index in exchange for
receiving
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Terms in bold type are defined in the Prospectus Glossary MAS Fund - 21
<PAGE>
interest streams denominated in another currency. Such Swaps may involve
initial and final exchanges that correspond to the agreed upon notional
amount.
The portfolio will usually enter into Swaps on a net basis, i.e., the two
return streams are netted out in a cash settlement on the payment date or
dates specified in the instrument, with the portfolio receiving or paying, as
the case may be, only the net amount of the two returns. The portfolio's
obligations under a swap agreement will be accrued daily (offset against any
amounts owing to the portfolio) and any accrued but unpaid net amounts owed to
a swap counterparty will be covered by the maintenance of a segregated account
consisting of cash or liquid securities. The portfolio will not enter into any
swap agreement unless the counterparty meets the rating requirements set forth
in guidelines established by the Board of Trustees.
Possible Risks: Interest rate and total rate of return Swaps do not involve
the delivery of securities, other underlying assets, or principal.
Accordingly, the risk of loss with respect to interest rate and total rate of
return Swaps is limited to the net amount of interest payments that the
portfolio is contractually obligated to make. If the other party to an
interest rate or total rate of return swap defaults, the portfolio's risk of
loss consists of the net amount of interest payments that the portfolio is
contractually entitled to receive. In contrast, currency swaps may involve the
delivery of the entire principal value of one designated currency in exchange
for the other designated currency. Therefore, the entire principal value of a
currency swap may be subject to the risk that the other party to the swap will
default on its contractual delivery obligations. If there is a default by the
counterparty, the portfolio may have contractual remedies pursuant to the
agreements related to the transaction. The swap market has grown substantially
in recent years with a large number of banks and investment banking firms
acting both as principals and as agents utilizing standardized swap
documentation. As a result, the swap market has become relatively liquid.
Swaps that include caps, floors, and collars are more recent innovations for
which standardized documentation has not yet been fully developed and,
accordingly, they are less liquid than Swaps.
The use of Swaps is a highly specialized activity which involves investment
techniques and risks different from those associated with ordinary portfolio
securities transactions. If the Adviser is incorrect in its forecasts of
market values, interest rates, and currency exchange rates, the investment
performance of the portfolio would be less favorable than it would have been
if this investment technique were not used.
U.S. Governments--U.S. Treasury securities: are Fixed-Income Securities which
are backed by the full faith and credit of the U.S. Government as to the
payment of both principal and interest.
When-Issued Securities: are securities purchased at a certain price even
though the securities may not be delivered for up to 90 days. No payment or
delivery is made by the portfolio in a when-issued transaction until the
portfolio receives payment or delivery from the other party to the
transaction. Although the portfolio receives no income from the above
described securities prior to delivery, the market value of such securities is
still subject to change. As a consequence, it is possible that the market
price of the securities at the time of delivery may be higher or lower than
the purchase price. The portfolio will maintain with the custodian a
segregated account consisting of cash or liquid securities in an amount at
least equal to these commitments.
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MAS Fund - 22 Terms in bold type are defined in the Prospectus Glossary
<PAGE>
Yankees: are U.S. dollar-denominated Fixed-Income Securities issued by a
foreign government or corporation and sold in the U.S.
Zero Coupons--Zero Coupon Obligations: are Fixed-Income Securities that do not
make regular interest payments. Instead, zero coupon obligations are sold at
substantial discounts from their face value. The difference between a zero
coupon obligation's issue or purchase price and its face value represents the
imputed interest an investor will earn if the obligation is held until
maturity. Zero Coupons may offer investors the opportunity to earn higher
yields than those available on ordinary interest-paying obligations of similar
credit quality and maturity. However, zero coupon obligation prices may also
exhibit greater price volatility than ordinary Fixed-Income Securities because
of the manner in which their principal and interest are returned to the
investor.
GENERAL SHAREHOLDER INFORMATION
PURCHASE OF SHARES
Institutional Class Shares are available to clients of the Adviser with
combined investments of $5,000,000 and Shareholder Organizations who have a
contractual arrangement with the Fund or the Fund's Distributor, including
institutions such as trusts, foundations or broker-dealers purchasing for the
accounts of others.
Institutional Class Shares of the portfolio may be purchased at the net asset
value per share next determined after receipt of the purchase order. The
portfolio determines net asset value as described under General Shareholder
Information-Valuation of Shares each day that the portfolio is open for
business. See Other Information-Closed Holidays and General Shareholder
Information--Valuation of Shares.
Initial Purchase by Mail: Subject to acceptance by the Fund, an account may be
opened by completing and signing an Account Registration Form (provided at the
end of the prospectus) and mailing it to MAS Funds c/o Miller Anderson &
Sherrerd, LLP, One Tower Bridge, West Conshohocken, Pennsylvania 19428-0868
together with a check ($5,000,000 minimum) payable to MAS Funds.
The portfolio should be designated on the Account Registration Form. Subject
to acceptance by the Fund, payment for the purchase of shares received by mail
will be credited at the net asset value per share of the portfolio next
determined after receipt. Such payment need not be converted into Federal
Funds (monies credited to the Fund's Custodian Bank by a Federal Reserve Bank)
before acceptance by the Fund. Please note that payments to investors who
redeem shares purchased by check will not be made until payment of the
purchase has been collected, which may take up to eight business days after
purchase. Shareholders can avoid this delay by purchasing shares by wire.
Initial Purchase by Wire: Subject to acceptance by the Fund, Institutional
Class Shares of the portfolio may also be purchased by wiring Federal Funds to
the Fund's Custodian Bank, The Chase Manhattan Bank (see instructions below).
A completed Account Registration Form should be forwarded to MAS Funds' Client
Services Group in
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Terms in bold type are defined in the Prospectus Glossary MAS Fund - 23
<PAGE>
advance of the wire. Notification must be given to MAS Funds' Client Services
Group at 1-800-354-8185 prior to the determination of net asset value.
Institutional Class Shares will be purchased at the net asset value per share
next determined after receipt of the purchase order. (Prior notification must
also be received from investors with existing accounts.) Instruct your bank to
send a Federal Funds Wire in a specified amount to the Fund's Custodian Bank
using the following wiring instructions:
The Chase Manhattan Bank
1 Chase Manhattan Plaza
New York, NY 10081
ABA #021000021
DDA #910-2-734143
Attn: MAS Funds Subscription Account
Ref: (Targeted Duration Portfolio, Account Number, Account Name)
Additional Investments: Additional investments of Institutional Class Shares
at net asset value may be made at any time (minimum additional investment
$1,000) by mailing a check (payable to MAS Funds) to MAS Funds' Client
Services Group at the address noted under Initial Purchase by Mail or by
wiring Federal Funds to the Custodian Bank as outlined above. Shares will be
purchased at the net asset value per share next determined after receipt of
the purchase order. Notification must be given to MAS Funds' Client Services
Group at 1-800-354-8185 prior to the determination of net asset value.
Other Purchase Information: The Fund reserves the right, in its sole
discretion, to suspend the offering of the portfolio or to reject any purchase
orders when, in the judgment of management, such suspension or rejection is in
the best interest of the Fund. The Fund also reserves the right, in its sole
discretion, to waive the minimum initial and additional investment amounts.
Purchases of the portfolio's shares will be made in full and fractional shares
of the portfolio calculated to three decimal places. In the interest of
economy and convenience, certificates for shares will not be issued except at
the written request of the shareholder. Certificates for fractional shares,
however, will not be issued.
Institutional Class Shares of the portfolio are also sold to corporations or
other institutions such as trusts, foundations or broker-dealers purchasing
for the accounts of others (Shareholder Organizations). Investors purchasing
and redeeming shares of the portfolio through a Shareholder Organization may
be charged a transaction-based fee or other fee for the services of such
organization. Each Shareholder Organization is responsible for transmitting to
its customers a schedule of any such fees and information regarding any
additional or different conditions regarding purchases and redemptions.
Customers of Shareholder Organizations should read this Prospectus in light of
the terms governing accounts with their organization. The Fund does not pay
compensation to or receive compensation from Shareholder Organizations for the
sale of Institutional Class Shares.
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MAS Fund - 24 Terms in bold type are defined in the Prospectus Glossary
<PAGE>
REDEMPTION OF SHARES
Shares of the portfolio may be redeemed by mail, or, if authorized, by
telephone. No charge is made for redemptions. The value of shares redeemed may
be more or less than the purchase price, depending on the net asset value at
the time of redemption which is based on the market value of the investment
securities held by the portfolio. See Other Information-Closed Holidays and
Valuation of Shares.
By Mail: The portfolio will redeem shares at the net asset value next
determined after the request is received in good order. Requests should be
addressed to MAS Funds, c/o Miller Anderson & Sherrerd, LLP, One Tower Bridge,
West Conshohocken, PA 19428-0868.
To be in good order, redemption requests must include the following
documentation:
(a) The share certificates, if issued;
(b) A letter of instruction, if required, or a stock assignment specifying the
number of shares or dollar amount to be redeemed, signed by all registered
owners of the shares in the exact names in which the shares are registered;
(c) Any required signature guarantees (see Signature Guarantees); and
(d) Other supporting legal documents, if required, in the case of estates,
trusts, guardianships, custodianships, corporations, pension and profit
sharing plans and other organizations.
Signature Guarantees: To protect your account, the Fund and the Administrator
from fraud, signature guarantees are required to enable the Fund to verify the
identity of the person who has authorized a redemption from an account.
Signature guarantees are required for (1) redemptions where the proceeds are
to be sent to someone other than the registered shareholder(s) and the
registered address, and (2) share transfer requests. Please contact MAS Funds'
Client Services Group for further details.
By Telephone: Provided the Telephone Redemption Option has been authorized by
the shareholder on the Account Registration Form, a redemption of shares may
be requested by calling MAS Funds' Client Services Group and requesting that
the redemption proceeds be mailed to the primary registration address or wired
per the authorized instructions. Shares cannot be redeemed by telephone if
share certificates are held for those shares.
By Facsimile: Written requests in good order (see above) for redemptions,
exchanges, and transfers may be forwarded to the Fund via facsimile. All
requests sent to the Fund via facsimile must be followed by a telephone call
to MAS Funds' Client Services Group to ensure that the instructions have been
properly received by the Fund. The original request must be promptly mailed to
MAS Funds, c/o Miller Anderson & Sherrerd, LLP, One Tower Bridge, West
Conshohocken, PA 19428-0868.
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Terms in bold type are defined in the Prospectus Glossary MAS Fund - 25
<PAGE>
Neither the Distributor nor the Fund will be responsible for any loss,
liability, cost, or expense for acting upon facsimile instructions or upon
telephone instructions that they reasonably believe to be genuine. In order to
confirm that telephone instructions in connection with redemptions are
genuine, the Fund and Distributor will provide written confirmation of
transactions initiated by telephone.
Payment of the redemption proceeds will ordinarily be made within three
business days after receipt of an order for a redemption. The Fund may suspend
the right of redemption or postpone the date of redemption at times when the
New York Stock Exchange ("NYSE"), the Custodian, or the Fund is closed (see
Other Information-Closed Holidays) or under any emergency circumstances as
determined by the SEC.
If the Board of Trustees determines that it would be detrimental to the best
interests of the remaining shareholders of the Fund to make payment wholly or
partly in cash, the Fund may pay the redemption proceeds in whole or in part
by a distribution in-kind of readily marketable securities held by a portfolio
in lieu of cash in conformity with applicable rules of the SEC. Investors may
incur brokerage charges on the sale of portfolio securities received in such
payments of redemptions.
SHAREHOLDER SERVICES
Exchange Privilege: The portfolio's Institutional Class Shares may be
exchanged for shares of the Fund's other portfolios offering Institutional
Class Shares based on the respective net asset values of the shares involved.
The exchange privilege is only available, however, with respect to portfolios
that are qualified for sale in a shareholder's state of residence. The Fund's
other portfolios are offered through a separate prospectus, which should be
obtained and read carefully before investing. There are no exchange fees.
Exchange requests should be sent to MAS Funds, c/o Miller Anderson & Sherrerd,
LLP, One Tower Bridge, West Conshohocken, PA 19428-0868.
Because an exchange of shares amounts to a redemption from one portfolio and
purchase of shares of another portfolio, the above information regarding
purchase and redemption of shares applies to exchanges. Shareholders should
note that an exchange between portfolios is considered a sale and purchase of
shares. The sale of shares may result in a capital gain or loss for tax
purposes.
The officers of the Fund reserve the right not to accept any request for an
exchange when, in their opinion, the exchange privilege is being used as a
tool for market timing. The Fund reserves the right to change the terms or
conditions of the exchange privilege discussed herein upon sixty days' notice.
Transfer of Registration: The registration of Fund shares may be transferred
by writing to MAS Funds, c/o Miller Anderson & Sherrerd, LLP, One Tower
Bridge, West Conshohocken, PA 19428-0868. As in the case of redemptions, the
written request must be received in good order as defined above. Unless shares
are being transferred to an existing account, requests for transfer must be
accompanied by a completed Account Registration Form for the receiving party.
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MAS Fund - 26 Terms in bold type are defined in the Prospectus Glossary
<PAGE>
VALUATION OF SHARES
Net asset value per share is computed by dividing the total value of the
investments and other assets of the portfolio, less any liabilities, by the
total outstanding shares of the portfolio. The net asset value per share is
determined as of one hour after the close of the bond markets (normally 4:00
p.m. Eastern Time) on each day the portfolio is open for business (See Other
Information-Closed Holidays). Bonds and other Fixed-Income Securities listed
on a foreign exchange are valued at the latest quoted sales price available
before the time when assets are valued. For purposes of net asset value per
share, all assets and liabilities initially expressed in foreign currencies
will be converted into U.S. dollars at the bid price of such currencies
against U.S. dollars.
Net asset value includes interest on bonds and other Fixed-Income Securities
which is accrued daily. Bonds and other Fixed-Income Securities which are
traded over the counter and on an exchange will be valued according to the
broadest and most representative market, and it is expected that for bonds and
other Fixed-Income Securities this ordinarily will be the over-the-counter
market.
However, bonds and other Fixed-Income Securities may be valued on the basis of
prices provided by a pricing service when such prices are believed to reflect
the fair market value of such securities. The prices provided by a pricing
service are determined without regard to bid or last sale prices but take into
account institutional size trading in similar groups of securities and any
developments related to specific securities. Bonds and other Fixed-Income
Securities not priced in this manner are valued at the most recent quoted bid
price, or when stock exchange valuations are used, at the latest quoted sale
price on the day of valuation. If there is no such reported sale, the latest
quoted bid price will be used. Securities purchased with remaining maturities
of 60 days or less are valued at amortized cost when the Board of Trustees
determines that amortized cost reflects fair value. In the event that
amortized cost does not approximate market, market prices as determined above
will be used. Other assets and securities, for which no quotations are readily
available (including restricted securities), and, to the extent permitted by
the SEC, securities for which the value has been materially affected by events
occurring after the close of the market on which they principally trade, will
be valued in good faith at fair value using methods approved by the Board of
Trustees.
DIVIDENDS, DISTRIBUTIONS AND TAXES
The portfolio normally distributes substantially all of its net investment
income to shareholders on a quarterly basis.
If the portfolio does not have income available to distribute, as determined
in compliance with the appropriate tax laws, no distribution will be made.
If any net gains are realized from the sale of underlying securities, the
portfolio normally distributes such gains with the last distribution for the
calendar year.
All dividends and capital gains distributions are automatically paid in
additional shares of the portfolio unless the shareholder elects otherwise.
Such election must be made in writing to the Fund and may be made on the
Account Registration Form.
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Terms in bold type are defined in the Prospectus Glossary MAS Fund - 27
<PAGE>
Undistributed net investment income is included in the portfolio's net assets
for the purpose of calculating net asset value per share. Therefore, on the
ex-dividend date, the net asset value per share excludes the dividend (i.e.,
is reduced by the per share amount of the dividend). Dividends paid shortly
after the purchase of shares by an investor, although in effect a return of
capital, are taxable as ordinary income.
Certain Mortgage Securities may provide for periodic or unscheduled payments
of principal and interest as the mortgages underlying the securities are paid
or prepaid. However, such principal payments (not otherwise characterized as
ordinary discount income or bond premium expense) will not normally be
considered as income to the portfolio and therefore will not be distributed as
dividends. Rather, these payments on mortgage-backed securities will be
reinvested on behalf of the shareholders by the portfolio in accordance with
its investment objectives and policies.
TAXES: The following is a summary of some important tax issues that affect the
portfolio and its shareholders. The summary is based on current tax laws and
regulations, which may be changed by legislative, judicial or administrative
action. No attempt has been made to present a detailed explanation of the tax
treatment of the portfolio or its shareholders. More information about taxes
is in the Statement of Additional Information. Shareholders are urged to
consult their tax advisors regarding specific questions as to federal, state
and local income taxes.
Federal Taxes: The portfolio is treated as a separate entity for federal
income tax purposes and intends to qualify for the special tax treatment
afforded regulated investment companies. As such, the portfolio will not be
subject to federal income tax to the extent it distributes net investment
company taxable income and net capital gains to shareholders. The Fund will
notify shareholders annually as to the tax classification of all
distributions.
Income dividends received by shareholders will be taxable as ordinary income,
whether received in cash or in additional shares.
Distributions paid in January but declared by the portfolio in October,
November or December of the previous year are taxable to shareholders in the
previous year.
The portfolio intends to declare and pay dividends and distributions so as to
avoid imposition of the federal excise tax applicable to regulated investment
companies. Further discussion is included in the Statement of Additional
Information.
The Fund is required by federal law to withhold 31% of reportable payments
(which may include dividends and capital gains distributions) paid to
shareholders. In order to avoid this withholding requirement, shareholders
must certify on their Account Registration Forms that their Social Security
Number or Taxpayer Identification Number is correct, and that they are not
subject to backup withholding. Exchanges and redemptions of shares in the
portfolio are taxable events.
Foreign Income Taxes: Investment income received by the portfolios from
sources within foreign countries may be subject to foreign income taxes
withheld at the source.
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MAS Fund - 28 Terms in bold type are defined in the Prospectus Glossary
<PAGE>
State and Local Income Taxes: The Fund is formed as a Pennsylvania Business
Trust and is not liable for any corporate income or franchise tax in the
Commonwealth of Pennsylvania. Shareholders should consult their tax advisors
for the state and local income tax consequences of distributions from the
portfolio.
TRUSTEES OF THE TRUST: The affairs of the Trust are supervised by the Trustees
under the laws governing business trusts in the Commonwealth of Pennsylvania.
The Trustees have approved contracts under which, as described above, certain
companies provide essential management, administrative and shareholder
services to the Trust.
INVESTMENT ADVISER: The Investment Adviser to the Fund, Miller Anderson &
Sherrerd, LLP (the "Adviser"), is a Pennsylvania limited liability partnership
founded in 1969, wholly owned by indirect subsidiaries of Morgan Stanley Dean
Witter & Co., and is located at One Tower Bridge, West Conshohocken, PA 19428.
The Adviser provides investment services to employee benefit plans, endowment
funds, foundations and other institutional investors and as of June 30, 1998
had in excess of $67 billion in assets under management. On May 31, 1997,
Morgan Stanley Group Inc., then the indirect parent of the Adviser, merged
with Dean Witter, Discover & Co. to form Morgan Stanley Dean Witter & Co.
(formerly, Morgan Stanley, Dean Witter, Discover & Co.) In connection with
this transaction, the Adviser entered into a new Investment Management
Agreement ("Agreement") with MAS Funds dated May 31, 1997, which Agreement was
approved by the shareholders of each portfolio at a special meeting held on
May 1, 1997 or at an adjournment of such meeting held on May 12, 1997. The
Adviser will retain its name and remain at its current location, One Tower
Bridge, West Conshohocken, PA 19428. The Adviser will continue to provide
investment counseling services to employee benefit plans, endowments,
foundations and other institutional investors.
Under the Agreement with the Fund, the Adviser, subject to the control and
supervision of the Fund's Board of Trustees and in conformance with the stated
investment objectives and policies of each portfolio of the Fund, manages the
investment and reinvestment of the assets of each portfolio of the Fund. In
this regard, it is the responsibility of the Adviser to make investment
decisions for the Fund's portfolios and to place each portfolio's purchase and
sales orders. As compensation for the services rendered by the Adviser under
the Agreement, the portfolio pays the Adviser an advisory fee calculated by
applying a quarterly rate based on an annualized fee of 0.375%.
PORTFOLIO MANAGEMENT
A description of the business experience during the past five years for each
of the investment professionals who are primarily responsible for the
day-to-day management of the portfolio is as follows:
Michele A. Kreisler, Vice President, joined MAS in 1994. She attended the
Wharton School of the University of Pennsylvania from 1990 to 1994. She served
as a Fixed Income Analyst from 1994 to 1995 and as a Portfolio Manager from
1995 to 1998. She assumed responsibility for the Targeted Duration Portfolio
in 1998.
Scott F. Richard, Managing Director, Morgan Stanley, joined MAS in 1992. He
assumed responsibility for the Mortgage-Backed Securities Portfolio in 1992,
the Limited Duration, Intermediate Duration, Municipal and PA Municipal
Portfolios in 1994, the Advisory Mortgage Portfolio in 1995 and the Targeted
Duration Portfolio in 1998.
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Terms in bold type are defined in the Prospectus Glossary MAS Fund - 29
<PAGE>
ADMINISTRATIVE SERVICES: MAS serves as Administrator to the Fund pursuant to
an Administration Agreement dated as of November 18, 1993. Under its
Administration Agreement with the Fund, MAS receives an annual fee, accrued
daily and payable monthly, of 0.08% of the Fund's average daily net assets,
and is responsible for all fees payable under any sub-administration
agreements. Chase Global Funds Services Company, a subsidiary of The Chase
Manhattan Bank, 73 Tremont Street, Boston MA 02108-3913, serves as Transfer
Agent to the Fund pursuant to an agreement also dated as of November 18, 1993,
and provides fund accounting and other services pursuant to a
sub-administration agreement with MAS as Administrator.
GENERAL DISTRIBUTION AGENT: Shares of the Fund are distributed exclusively
through MAS Fund Distribution, Inc., a wholly-owned subsidiary of the Adviser.
PORTFOLIO TRANSACTIONS: The investment advisory agreement authorizes the
Adviser to select the brokers or dealers that will execute the purchases and
sales of investment securities for each of the Fund's portfolios and directs
the Adviser to use its best efforts to obtain the best execution with respect
to all transactions for the portfolios. In doing so, a portfolio may pay
higher commission rates or markups on principal transactions than the lowest
available when the Adviser believes it is reasonable to do so in light of the
value of the research, statistical, and pricing services provided by the
broker or dealer effecting the transaction.
It is not the Fund's practice to allocate brokerage or principal business on
the basis of sales of shares which may be made through intermediary brokers or
dealers. However, the Adviser may place portfolio orders with qualified
broker-dealers who recommend the Fund's portfolios or who act as agents in the
purchase of shares of the portfolios for their clients.
Some securities considered for investment by each of the Fund's portfolios may
also be appropriate for other clients served by the Adviser. The Adviser may
place a combined order for two or more accounts or portfolios for the purchase
or sale of the same security if, in its judgement, joint execution is in the
best interest of each participant and will result in best price and execution.
If purchase or sale of securities consistent with the investment policies of a
portfolio and one or more of these other clients served by the Adviser is
considered at or about the same time, transactions in such securities will be
allocated among the portfolio and clients in a manner deemed fair and
reasonable by the Adviser. Although there is no specified formula for
allocating such transactions, the various allocation methods used by the
Adviser, and the results of such allocations, are subject to periodic review
by the Fund's Trustees. The Adviser may use its broker dealer affiliates,
including Morgan Stanley & Co., a wholly owned subsidiary of Morgan Stanley
Dean Witter & Co., the parent of MAS's general partner and limited partner, to
carry out the Fund's transactions, provided the Fund receives brokerage
services and commission rates comparable to those of other broker dealers.
OTHER INFORMATION: Description of Shares and Voting Rights: The Fund was
established under Pennsylvania law by a Declaration of Trust dated February
15, 1984, as amended and restated as of November 18, 1993. The Fund is
authorized to issue an unlimited number of shares of beneficial interest,
without par value, from an unlimited number of series (portfolios) of shares.
Currently the Fund consists of thirty-one portfolios.
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MAS Fund - 30 Terms in bold type are defined in the Prospectus Glossary
<PAGE>
The shares of the Fund are fully paid and non-assessable, and have no
preference as to conversion, exchange, dividends, retirement or other
features. The shares of the Fund have no preemptive rights. The shares of the
Fund have non-cumulative voting rights, which means that the holders of more
than 50% of the shares voting for the election of Trustees can elect 100% of
the Trustees if they choose to do so. Shareholders are entitled to one vote
for each full share held (and a fractional vote for each fractional share
held), then standing in their name on the books of the Fund.
Meetings of shareholders will not be held except as required by the 1940 Act
and other applicable law. A meeting will be held to vote on the removal of a
Trustee or Trustees of the Fund if requested in writing by the holders of not
less than 10% of the outstanding shares of the Fund. The Fund will assist in
shareholder communication in such matters to the extent required by law.
Custodians: The Chase Manhattan Bank, New York, NY and Morgan Stanley Trust
Company (NY), Brooklyn, NY serve as custodians for the Fund. The custodians
hold cash, securities and other assets as required by the 1940 Act.
Transfer and Dividend Disbursing Agent: Chase Global Funds Services Company, a
subsidiary of The Chase Manhattan Bank, 73 Tremont Street, Boston, MA
02108-3913, serves as the Funds' Transfer Agent and dividend disbursing agent.
Reports: Shareholders receive semi-annual and annual financial statements.
Annual financial statements are audited by PricewaterhouseCoopers LLP,
independent accountants.
Litigation: The Fund is not involved in any litigation.
Closed Holidays: Currently, the weekdays on which the Fund is closed for
business are: New Year's Day, Martin Luther King, Jr. Day, Presidents' Day,
Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and
Christmas Day.
Year 2000: The management and distribution services provided to the Fund by
the Adviser and the Distributor depend on the smooth functioning of their
computer systems. Many computer software systems in use today cannot recognize
the year 2000, but revert to 1900 or 1980, due to the manner in which dates
were encoded and calculated. That failure could have a negative impact on the
handling of securities trades, pricing and account services. The Adviser and
the Distributor have been actively working on necessary changes to their own
computer systems to deal with the year 2000 problem and expect that their
systems will be adapted before that date. There can be no assurance, however,
that they will be successful. In addition, other unaffiliated service
providers may be faced with similar problems. The Adviser and the Distributor
are monitoring their remedial efforts, however, there can be no assurance that
they and the services they provide will not be adversely affected.
In addition, it is possible that the markets for securities in which the
portfolios invest may be detrimentally affected by computer failures
throughout the financial services industry beginning January 1, 2000.
Improperly functioning trading
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Terms in bold type are defined in the Prospectus Glossary MAS Fund - 31
<PAGE>
systems may result in settlement problems and liquidity issues. In addition,
corporate and governmental data processing errors may result in production
problems for individual companies and overall economic uncertainties. Earnings
of individual issuers will be affected by remediation costs, which may be
substantial and may be reported inconsistently in U.S. and foreign financial
statements. Accordingly, the portfolio's investments may be adversely
affected.
TRUSTEES AND OFFICERS
The following is a list of the Trustees and the principal executive officers
of the Fund and a brief statement of their present positions and principal
occupations during the past five years:
Thomas L. Bennett,* Chairman of the Board of Trustees; Managing Director,
Morgan Stanley; Portfolio Manager and member of the Executive Committee,
Miller Anderson & Sherrerd, LLP; Director, MAS Fund Distribution, Inc.;
formerly, Director, Morgan Stanley Universal Funds, Inc.
Thomas P. Gerrity, Trustee; Dean and Reliance Professor of Management and
Private Enterprise, Wharton School of Business, University of Pennsylvania;
Director, Digital Equipment Corporation; Director, Sun Company, Inc.;
Director, Fannie Mae; Director, Reliance Group Holdings; Director, CVS
Corporation; Director, IKON Office Solutions, Inc.; Director, Knight-Ridder,
Inc.; formerly, Director, Union Carbide Corporation.
Joseph P. Healey, Trustee; Headmaster, Haverford School; formerly Dean, Hobart
College; Associate Dean, William & Mary College.
Joseph J. Kearns, Trustee; investment consultant; Chief Investment Officer,
The J. Paul Getty Trust; Director, Electro Rent Corporation; Trustee, Southern
California Edison Nuclear Decommissioning Trust; Director, The Ford Family
Foundation.
Vincent R. McLean, Trustee; Director, Legal and General America, Inc.;
Director, William Penn Life Insurance Company of New York; formerly, Executive
Vice President, Chief Financial Officer, Director and Member of the Executive
Committee of Sperry Corporation (now part of Unisys Corporation).
C. Oscar Morong, Jr., Trustee; Managing Director, Morong Capital Management;
Director, Ministers and Missionaries Benefit Board of American Baptist
Churches, The Indonesia Fund, The Landmark Funds; formerly, Senior Vice
President and Investment Manager for CREF, TIAA-CREF Investment Management,
Inc.
*Trustee Bennett is deemed to be an "interested person" of the Fund as that
term is defined in the Investment Company Act of 1940, as amended.
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MAS Fund - 32 Terms in bold type are defined in the Prospectus Glossary
<PAGE>
James D. Schmid, President, MAS Funds; Principal, Morgan Stanley; Head of
Mutual Funds, Miller Anderson & Sherrerd, LLP; Director, MAS Fund
Distribution, Inc.; formerly, Chairman of the Board of Directors, The Minerva
Fund, Inc.; formerly, Vice President, The Chase Manhattan Bank.
Lorraine Truten, CFA, Vice President, MAS Funds; Principal, Morgan Stanley;
Head of Mutual Fund Services, Miller Anderson & Sherrerd, LLP; President, MAS
Fund Distribution, Inc.
James A. Gallo, Treasurer, MAS Funds; Head of Fund Administration, Miller,
Anderson and Sherrerd, LLP; formerly, Manager, Investment Accounting and then
Vice President and Director of Investment Accounting, PFPC, Inc.
John H. Grady, Jr., Secretary, MAS Funds; Partner, Morgan, Lewis & Bockius
LLP.
Richard J. Shoch, Assistant Secretary, MAS Funds; Fund Compliance Officer,
Miller, Anderson & Sherrerd, LLP; formerly, Fund Legal Administrator and then
Counsel, Vice President and Assistant Secretary, SEI Corporation.
- --------------------------------------------------------------------------------
Terms in bold type are defined in the Prospectus Glossary MAS Fund - 33
<PAGE>
(This page intentionally left blank)
- ------------------------------------------------------------------------------
MAS Fund - 34 Terms in bold type are defined in the Prospectus Glossary
<PAGE>
<TABLE>
<S> <C>
- --MAS---------------------------------------------------------------------------------ACCOUNT REGISTRATION FORM---------------------
MAS FUNDS
MAS Fund Distribution, Inc.
General Distribution Agent
- ------------------------------------------------------------------------------------------------------------------------------------
(1) |
REGISTRATION/PRIMARY ||_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|
|
MAILING ADDRESS ||_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|
|
| Attention |_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|
Confirmations and |
month-end statements | Street or P.O. Box |_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|
will be mailed |
to this address. | City |_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_| State |_|_| Zip |_|_|_|_|_| |_|_|_|_|
|
| Telephone No. |_|_|_|-|_|_|_|-|_|_|_|_|_|
|
| Form of Business
| Entity: [ ] Corporation [ ] Partnership [ ] Trust [ ] Other _____________________________
| Type of Account: [ ] Defined Benefit Plan [ ] Defined Contribution Plan [ ] Profit Sharing/Thrift Plan
|
| [ ] Other Employee Benefit Plan ___________________________________________
|
| [ ] Endowment [ ] Foundation [ ] Taxable [ ] Other (Specify)_________
|
| [ ] United States Citizen [ ] Resident Alien [ ] Non-Resident Alien, Indicate Country of Residence _______
- ------------------------------------------------------------------------------------------------------------------------------------
(2) |
INTERESTED PARTY |
OPTION |
|
In addition to the |
account statement |
sent to the above | Attention |_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|
registered address, | Company
the Fund is | (If Applicable) |_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|
authorized to mail |
duplicate statements | Street or P.O. Box |_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|
to the name and |
address provided | City |_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_|_| State |_|_| Zip |_|_|_|_|_| |_|_|_|_|
at right. |
| Telephone No. |_|_|_|-|_|_|_|-|_|_|_|_|_|
For additional |
interested party |
mailings, please |
attach a separate |
sheet. |
- ------------------------------------------------------------------------------------------------------------------------------------
(3) INVESTMENT [ ] Targeted Duration Portfolio
For Purchase of:
- ------------------------------------------------------------------------------------------------------------------------------------
(4) TAXPAYER IDENTIFICATION NUMBER
Part 1.
Social Security Number IMPORTANT TAX INFORMATION
|_|_|_|-|_|_|-|_|_|_|_| You (as a payee) are required by law to provide us (as payer) with your correct
taxpayer identification number. Accounts that have a missing or incorrect
or taxpayer identification number will be subject to backup withholding at a 31%
Employer Identification Number rate on ordinary income and capital gains distribution as well as redemptions.
Backup withholding is not an additional tax; the tax liability of person subjects
|_|_|-|_|_|_|_|_|_|_| to backup withholding will be reduced by the amount of tax withheld.
Part 2. BACKUP WITHHOLDING You may be notified that you are subject to backup withholding under section
3406(a)(1)(C) because you have underreported interest or dividends or you were
[ ] Check the box if the account required to, but failed to, file a return which would have included a reportable
Backup Withholding under the provisions interest or dividend payment. If you have been so notified, check
of Section 3406(a)(1)(C) of the the box in PART 2 at left.
Internal Revenue Code.
- ------------------------------------------------------------------------------------------------------------------------------------
MILLER
ANDERSON
__& SHERRERD, LLP __ ONE TOWER BRIDGE o WEST CONSHOHOCKEN, PA 19428 o 800-354-8185 ________________________________________________
SIDE ONE OF TWO +
<PAGE>
- --MAS-------------------------------------------------------------------------------------------------------------------------------
MAS FUNDS
(5) TELEPHONE REDEMPTION OPTION
Please sign below if you wish to redeem or exchange shares by telephone. Redemption proceeds requested by phone may only be mailed
to the account's primary registration address or wired according to bank instructions provided in writing. A signature guarantee is
required if the bank account listed below is not registered identically to your Fund Account. The Fund and its agents shall not be
liable for reliance on phone instructions reasonably believed to be genuine. The Fund will maintain procedures designed to
authenticate telephone instructions received.
Telephone requests for redemptions or exchanges will not be honored unless signature appears below.
(X)
- -----------------------------------------------------------------------------------------------
Signature Date
- ------------------------------------------------------------------------------------------------------------------------------------
(6) WIRING INSTRUCTIONS -- The instructions provided below may only be changed by written notification.
Please check appropriate box(es):
[ ] Wire redemption proceeds
[ ] Wire distribution proceeds (please complete box (7) below)
____________________________________________________________________ _____________________________________________
Name of Commercial Bank (Net Savings Bank) Bank Account No.
____________________________________________________________________________________________________________________________
Name(s) in which your Bank Account is Established
____________________________________________________________________________________________________________________________
Bank's Street Address
___________________________________________________________________________________________ ______________________________
City State Zip Routing/ABA Number
- ------------------------------------------------------------------------------------------------------------------------------------
(7) DISTRIBUTION OPTION -- Income dividends and capital gains distributions (if | (8) WIRING
any) will be reinvested in additional shares if no box is checked below. The | INSTRUCTIONS
instructions provided below may only be changed by written notification. | For purchasing Shares by wire,
| please send a Fedwire payment to:
|
[ ] Income dividends and capital gains to be paid in cash. | The Chase Manhattan Bank
| 1 Chase Manhattan Plaza
[ ] Income dividends to be paid in cash and capital gains distribution in | New York, NY 10081
additional shares. | ABA# 021000021
| DDA# 910-2-734143
[ ] Income dividends and capital gains to be reinvested in |
additional shares. | Attn: MAS Funds Subscription Account
| Ref. (Targeted Duration Portfolio, your
If cash option is chosen, please indicate instructions below: | Account number,
|
[ ] Mail distribution check to the name and address in which account is |
registered. |
|
[ ] Wire distribution to the same commercial bank indicated in Section 6 above. |
|
- ------------------------------------------------------------------------------------------------------------------------------------
SIGNATURE(S) OF ALL HOLDERS AND TAXPAYER CERTIFICATION
The undersigned certify that I/we have full authority and legal capacity to purchase shares of the Fund and affirm that I/we have
received a current MAS Funds Prospectus and agree to be bound by its terms. Under penalties of perjury I/we certify that the
information provided in Section 4 above is true, correct and complete. The Internal Revenue Service does not require your consent to
any provision of this document other than the certifications required to avoid backup withholding.
(X)__________________________________________________________ ______________________________________________________________
Signature Date | |
| |
(X)__________________________________________________________ | FOR INTERNAL USE ONLY |
Signature Date | |
| (X)________________________________________________________ |
(X)__________________________________________________________ | Signature Date |
Signature Date | |
| __________________________________________________________ |
(X)__________________________________________________________ | |
Signature Date | O [ ] F [ ] |
| |
This application is separate from the prospectus. | |
|______________________________________________________________|
MILLER
ANDERSON
__& SHERRERD, LLP __ ONE TOWER BRIDGE o WEST CONSHOHOCKEN, PA 19428 o 800-354-8185 ________________________________________________
SIDE TWO OF TWO
</TABLE>
<PAGE>
Targeted Duration Portfolio
September 28, 1998
Investment Adviser and Administrator: Transfer Agent:
Miller Anderson & Sherrerd, LLP Chase Global Funds Services Company
One Tower Bridge 73 Tremont Street
West Conshohocken, Boston, Massachusetts 02108-0913
Pennsylvania 19428-2899
General Distribution Agent:
MAS Fund Distribution, Inc.
One Tower Bridge
P.O. Box 868
West Conshohocken,
Pennsylvania 19428-0868
- ------------------------------------------------------------------------------
Table of Contents
Page Page
Fund Expenses 2 Shareholder Services 26
Prospectus Summary 4 Valuation of Shares 27
Yield and Total Return 5 Dividends, Distributions and Taxes 27
Investment Suitability 6 Investment Adviser 29
Investment Limitations 7 Portfolio Management 29
Portfolio Summary 8 Administrative Services 30
Prospectus Glossary General Distribution Agent 30
Strategies 9 Portfolio Transactions 30
Investments 12 Other Information 30
General Shareholder Information Trustees and Officers 32
Purchase of Shares 23
Redemption of Shares 25
- --------------------------------------------------------------------------------
Terms in bold type are defined in the Prospectus Glossary MAS Fund - 37
<PAGE>
- -------------MAS------------------------------------------
---------
MAS FUNDS
------------------------------------------------
INSTITUTIONAL CLASS
PROSPECTUS
------------------------------------------------
MILLER
ANDERSON
& SHERRERD, LLP
____________ ONE TOWER BRIDGE o WEST CONSHOHOCKEN, PA 19428 o 800-354-8185 _____
<PAGE>
MAS FUNDS - TARGETED DURATION PORTFOLIO
STATEMENT OF ADDITIONAL INFORMATION
September 28, 1998
MAS Funds (the "Fund") is a no load mutual fund consisting of thirty-one
portfolios offering a variety of investment alternatives. This Statement
of Additional Information sets forth information about the Targeted
Duration Portfolio (the "portfolio"). The portfolio had not commenced
operations as of September 30, 1997.
This Statement is not a prospectus but should be read in conjunction with
the Fund's prospectus dated September 28, 1998, as revised from time to
time. To obtain the prospectus, please call the Client Services Group.
Client Services Group: 1-800-354-8185
Prices and Investment Results: 1-800-522-1525
TABLE OF CONTENTS
Page
----
Business History 1
Strategies and Investments 1
Duration 1
Mortgage-Backed Securities 1
Stripped Mortgage-Backed Securities 3
Restricted Securities 4
U.S. Government Securities 4
Eurodollar and Yankee Obligations 4
Municipal Bonds 5
Zero Coupon Bonds 6
Brady Bonds 6
Repurchase Agreements 7
Securities Lending 7
Foreign Investments 8
Futures Contracts 9
Restrictions on the Use of Futures Contracts 9
Risk Factors in Futures Transactions 10
Options 10
Options on Foreign Currencies 11
Combined Transactions 12
Risks of Options on Futures Contracts, Forward Contracts
and Options on Foreign Currencies 12
Swap Contracts 13
Foreign Currency Exchange-Related Securities 14
Tax Considerations 15
Purchase of Shares 17
Redemption of Shares 17
Transactions with Broker/Dealers 17
Shareholder Services 18
Investment Limitations 18
i
<PAGE>
Management of the Fund 20
Investment Adviser 22
Administration 23
Distributor for Fund 23
Custodians 23
Portfolio Transactions 24
General Information 25
Performance Information 27
Comparative Index 28
Financial Statements 28
Appendix-description of Securities and Ratings 29
ii
<PAGE>
BUSINESS HISTORY
MAS Funds (formerly MAS Pooled Trust Fund) is an open end management
investment company established under Pennsylvania law as a Pennsylvania
business trust under an Amended and Restated Agreement and Declaration of
Trust dated November 18, 1993. The Fund was originally established as The MAS
Pooled Trust Fund, a Pennsylvania business trust, in February, 1984.
STRATEGIES AND INVESTMENTS
The following information supplements the characteristics and risks of
strategies and investments set forth in the portfolio's prospectus:
DURATION
The Targeted Duration Portfolio seeks to achieve its objectives by investing
in the types of fixed income securities described in the prospectus and by
maintaining an average duration approximating that of the Merrill Lynch 1-3
Year Government Bond Index. Duration is one of the fundamental tools used by
the Adviser in security selection for the portfolio.
Duration is a measure of the expected life of a fixed income security that was
developed as a more precise alternative to the concept of the "term of
maturity." Duration incorporates a bond's yield, coupon interest payments,
final maturity and call features into one measure.
Most debt obligations provide interest ("coupon") payments in addition to a
final ("par") payment at maturity. Some obligations also have call provisions.
Depending on the relative magnitude of these payments, the market values of
debt obligations may respond differently to changes in the level and structure
of interest rates.
Traditionally, a debt security's "term to maturity" has been used as a proxy
for the sensitivity of the security's price to changes in interest rates
(which is the "interest rate risk" or "volatility" of the security). However,
"term to maturity" measures only the time until a debt security provides its
final payment, taking no account of the pattern of the security's payments
prior to maturity. Duration is a measure of the expected life of a fixed
income security on a present value basis. Duration takes the length of the
time intervals between the present time and the time that the interest and
principal payments are scheduled or, in the case of a callable bond, expected
to be received, and weights them by the present values of the cash to be
received at each future point in time. For any fixed income security with
interest payments occurring prior to the payment of principal, duration is
always less than maturity. In general, all other things being the same, the
lower the stated or coupon rate of interest of a fixed income security, the
longer the duration of the security; conversely, the higher the stated or
coupon rate of interest of a fixed income security, the shorter the duration
of the security.
There are some situations where even the standard duration calculation does
not properly reflect the interest rate exposure of a security. For example, in
the case of mortgage-backed securities, the current prepayment rates are more
critical than their stated final maturities in determining their interest rate
exposure. In these and other similar situations, the Adviser will use more
sophisticated analytical techniques that incorporate the economic life of a
security into the determination of its interest rate exposure.
MORTGAGE-BACKED SECURITIES
Mortgage-backed securities represent an ownership interest in a pool of
residential mortgage loans. These securities are designed to provide monthly
payments of interest and principal to the investor. The mortgagor's monthly
payments to his/her lending institution are "passed-through" to investors.
Most issuers or poolers provide guarantees of payments, regardless of whether
or not the mortgagor actually makes the payment. The guarantees made by
issuers or poolers are individual loan, title, pool and hazard insurance
purchased by the issuer. There can be no assurance that the private issuers
can meet their obligations under the policies. Mortgage-backed securities
<PAGE>
issued by private issuers, whether or not such securities are subject to
guarantees, may entail greater risk. If there is no guarantee provided by the
issuer, mortgage-backed securities purchased by the portfolios will be rated
investment grade by Moody's or Standard & Poor's, or, if unrated, deemed by
the Adviser to be of investment grade quality.
Underlying Mortgages
Pools consist of whole mortgage loans or participation in loans. The majority
of these loans are made to purchasers of 1-4 family homes. The terms and
characteristics of the mortgage instruments are generally uniform within a
pool but may vary among pools. For example, in addition to fixed-rate
fixed-term mortgages, the portfolio may purchase pools of adjustable rate
mortgages (ARM), growing equity mortgages (GEM), graduated payment mortgage
(GPM) and other types where the principal and interest payment procedures
vary. ARM's are mortgages which reset the mortgage's interest rate with
changes in open market interest rates. The portfolio's interest income will
vary with changes in the applicable interest rate on pools of ARM's. GPM and
GEM pools maintain constant interest rates, with varying levels of principal
repayment over the life of the mortgage. These different interest and
principal payment procedures should not impact the portfolio's net asset
values since the prices at which these securities are valued each day will
reflect the payment procedures.
All poolers apply standards for qualifications to local lending institutions
which originate mortgages for the pools. Poolers also establish credit
standards and underwriting criteria for individual mortgages included in the
pools. In addition, many mortgages included in pools are insured through
private mortgage insurance companies.
Average Life
The average life of pass-through pools varies with the maturities, coupon
rates, and type of the underlying mortgage instruments. In addition, a pool's
term may be shortened by unscheduled or early payments of principal and
interest on the underlying mortgages. The occurrence of mortgage prepayments
is affected by factors including the level of interest rates, general economic
conditions, the location and age of the mortgage and other social and
demographic conditions.
Returns of Mortgage-Backed Securities
Yields on mortgage-backed pass-through securities are typically quoted based
on a prepayment assumption derived from the coupon and maturity of the
underlying instruments. Actual prepayment experience may cause the realized
return to differ from the assumed yield. Reinvestment of prepayments may occur
at higher or lower interest rates than the original investment, thus affecting
the realized returns of the portfolios. The compounding effect from
reinvestment of monthly payments received by the portfolio will increase its
return to shareholders, compared to bonds that pay interest semi-annually.
About Mortgage-Backed Securities
Interests in pools of mortgage-backed securities differ from other forms of
debt securities, which normally provide for periodic payment of interest in
fixed amounts with principal payments at maturity or specified call dates.
Instead, these securities provide a monthly payment which consists of both
interest and principal payments. In effect, these payments are a
"pass-through" of the monthly payments made by the individual borrowers on
their residential mortgage loans, net of any fees paid to the issuer or
guarantor of such securities. Additional payments are caused by repayments
resulting from the sale of the underlying residential property, refinancing or
foreclosure net of fees or costs which may be incurred. Some mortgage-backed
securities are described as "modified pass-through." These securities entitle
the holders to receive all interest and principal payments owed on the
mortgages in the pool, net of certain fees, regardless of whether or not the
mortgagors actually make payment.
2
<PAGE>
Residential mortgage loans are pooled by the Federal Home Loan Mortgage
Corporation (FHLMC). FHLMC is a corporate instrumentality of the U.S.
Government and was created by Congress in 1970 for the purpose of increasing
the availability of mortgage credit for residential housing. FHLMC issues
Participation Certificates ("PC's") which represent interests in mortgages
from FHLMC's national portfolio. FHLMC guarantees the timely payment of
interest and ultimate collection of principal.
Fannie Mae is a Government-sponsored corporation owned entirely by private
stockholders. It is subject to general regulation by the Secretary of Housing
and Urban Development. Fannie Mae purchases residential mortgages from a list
of approved seller/servicers which include state and federally-chartered
savings and loan associations, mutual savings, banks, commercial banks and
credit unions and mortgage bankers. Pass-through securities issued by Fannie
Mae are guaranteed as to timely payment of principal and interest by Fannie
Mae.
The principal Government guarantor of mortgage-backed securities is the
Government National Mortgage Association (GNMA). GNMA is a wholly-owned U.S.
Government corporation within the Department of Housing and Urban Development.
GNMA is authorized to guarantee, with the full faith and credit of the U.S.
Government, the timely payment of principal and interest on securities issued
by approved institutions and backed by pools of FHA-insured or VA-guaranteed
mortgages.
Commercial banks, savings and loan institutions, private mortgage insurance
companies, mortgage bankers and other secondary market issuers also create
pass-through pools of conventional residential mortgage loans. Pools created
by such non-governmental issuers generally offer a higher rate of interest
than Government and Government-related pools because there are no direct or
indirect Government guarantees of payments in the former pools. However,
timely payment of interest and principal of these pools is supported by
various forms of insurance or guarantees, including individual loan, title,
pool and hazard insurance purchased by the issuer. The insurance and
guarantees are issued by Governmental entities, private insurers and the
mortgage poolers. There can be no assurance that the private insurers can meet
their obligations under the policies. Mortgage-backed securities purchased for
the portfolio will, however, be rated of investment grade quality by Moody's
and/or Standard & Poor's or, if unrated, deemed by the Adviser to be of
investment grade quality.
It is expected that Governmental or private entities may create mortgage loan
pools offering pass-through investments in addition to those described above.
The mortgages underlying these securities may be alternative mortgage
instruments, that is, mortgage instruments whose principal or interest payment
may vary or whose terms to maturity may be shorter than previously customary.
As new types of mortgage-backed securities are developed and offered to
investors, the portfolio will, consistent with its investment objective and
policies, consider making investments in such new types of securities.
STRIPPED MORTGAGE-BACKED SECURITIES
Stripped mortgage-backed securities ("SMBS") are derivative multiclass
mortgage securities. SMBS may be issued by agencies or instrumentalities of
the U.S. Government or by private originators of, or investors in, mortgage
loans, including savings and loan associations, mortgage banks, commercial
banks, investment banks and special purpose entities of the foregoing.
SMBS are usually structured with two classes that receive different
proportions of the interest and principal distributions on a pool of mortgage
assets. A common type of SMBS will have one class receiving some of the
interest and most of the principal from the mortgage assets, while the other
class will receive most of the interest and the remainder of the principal. In
the most extreme case, one class will receive all of the interest (the
interest-only or "IO" class), while the other class will receive all of the
principal (the principal-only or "PO" class). The yield to maturity on an IO
class is extremely sensitive to the rate of principal payments (including
prepayments) on the related underlying mortgage assets, and a rapid rate of
principal payments may have a material adverse effect on the portfolio's yield
to maturity from these securities. If the underlying mortgage assets
3
<PAGE>
experience greater than anticipated prepayments of principal, the portfolio may
fail to fully recoup its initial investment in these securities even if the
security is in one of the highest rating categories.
SMBS are generally purchased and sold by institutional investors through
several investment banking firms acting as brokers or dealers. Certain of
these securities may be deemed "illiquid" and subject to the portfolio's
limitation on investing in illiquid securities.
RESTRICTED SECURITIES
In determining whether restricted securities are liquid, a number of factors
are considered such as: frequency of trades, the number of dealers willing to
purchase or sell the security, and the number of potential buyers.
U.S. GOVERNMENT SECURITIES
The term "U.S. Government securities" refers to a variety of securities which
are issued or guaranteed by the U.S. Government, and by various
instrumentalities which have been established or sponsored by the U.S.
Government. U.S. Treasury securities are backed by the "full faith and credit"
of the U.S.
Agency Securities: Securities issued or guaranteed by federal agencies and
U.S. Government sponsored instrumentalities may or may not be backed by the
full faith and credit of the U.S.
In the case of securities not backed by the full faith and credit of the U.S.,
the investor must look principally to the agency or instrumentality issuing or
guaranteeing the obligation for ultimate repayment, and may not be able to
assert a claim against the U.S. itself in the event the agency or
instrumentality does not meet its commitment. Agencies which are backed by the
full faith and credit of the U.S. include the Export Import Bank, Farmers Home
Administration, Federal Financing Bank, and others. Certain debt issued by
Resolution Funding Corporation has both its principal and interest backed by
the full faith and credit of the U.S. Treasury in that its principal is
defeased by U.S. Treasury zero coupon issues, while the U.S. Treasury is
explicitly required to advance funds sufficient to pay interest on it, if
needed. Certain agencies and instrumentalities, such as the Government
National Mortgage Association, are, in effect, backed by the full faith and
credit of the U.S. through provisions in their charters that they may make
"indefinite and unlimited" drawings on the Treasury, if needed to service its
debt. Debt from certain other agencies and instrumentalities, including the
Federal Home Loan Bank and Fannie Mae, are not guaranteed by the U.S., but
those institutions are protected by the discretionary authority of the U.S.
Treasury to purchase certain amounts of their securities to assist the
institution in meeting its debt obligations. Finally, other agencies and
instrumentalities, such as the Farm Credit System and the Federal Home Loan
Mortgage Corporation, are federally chartered institutions under Government
supervision, but their debt securities are backed only by the credit
worthiness of those institutions, not the U.S. Government.
Some of the U.S. Government agencies that issue or guarantee securities
include the Export-Import Bank of the U.S., Farmers Home Administration,
Federal Housing Administration, Maritime Administration, Small Business
Administration and The Tennessee Valley Authority.
An instrumentality of the U.S. Government is a Government agency organized
under federal charter with Government supervision. Instrumentalities issuing
or guaranteeing securities include, among others, Federal Home Loan Banks, the
Federal Land Banks, Central Bank for Cooperatives, Federal Intermediate Credit
Banks and Fannie Mae.
EURODOLLAR AND YANKEE OBLIGATIONS
The portfolio can invest in Eurodollar and Yankee obligations. Eurodollar bank
obligations are dollar-denominated certificates of deposit and time deposits
issued outside the U.S. capital markets by foreign branches of U.S. banks
4
<PAGE>
and by foreign banks. Yankee bank obligations are dollar-denominated
obligations issued in the U.S. capital markets by foreign banks.
Eurodollar and Yankee obligations are subject to the same risks that pertain
to domestic issues, notably credit risk, market risk and liquidity risk.
Additionally, Eurodollar (and to a limited extent, Yankee) obligations are
subject to certain sovereign risks. One such risk is the possibility that a
sovereign country might prevent capital, in the form of dollars, from flowing
across their borders. Other risks include: adverse political and economic
developments; the extent and quality of government regulation of financial
markets and institutions; the imposition of foreign withholding taxes, and the
expropriation or nationalization of foreign issuers.
MUNICIPAL BONDS
Municipal bonds generally include debt obligations issued by states and their
political subdivisions, and duly constituted authorities and corporations, to
obtain funds to construct, repair or improve various public facilities such as
airports, bridges, highways, hospitals, housing, schools, streets and water
and sewer works. Municipal bonds may also be issued to refinance outstanding
obligations as well as to obtain funds for general operating expenses and for
loans to other public institutions and facilities.
The two principal classifications of municipal bonds are "general obligation"
and "revenue" or "special tax" bonds. General obligation bonds are secured by
the issuer's pledge of its full faith, credit and taxing power for the payment
of principal and interest. Revenue or special tax bonds are payable only from
the revenues derived from a particular facility or class of facilities or, in
some cases, from the proceeds of a special excise or other tax, but not from
general tax revenues. The portfolio may also invest in tax-exempt industrial
development bonds, short-term municipal obligations, project notes, demand
notes and tax-exempt commercial paper.
Industrial development bonds in most cases are revenue bonds and generally do
not have the pledge of the credit of the issuer. The payment of the principal
and interest on such industrial development bonds is dependent solely on the
ability of the user of the facilities financed by the bonds to meet its
financial obligations and the pledge, if any, of real and personal property so
financed as security for such payment. Short-term municipal obligations issued
by states, cities, municipalities or municipal agencies, include tax
anticipation notes, revenue anticipation notes, bond anticipation notes,
construction loan notes and short-term discount notes. Project notes are
instruments issued by the Department of Housing and Urban Development but
issued by a state or local housing agency. While the issuing agency has the
primary obligation on such project notes, they are also secured by the full
faith and credit of the U.S.
Note obligations with demand or put options may have a stated maturity in
excess of one year, but permit any holder to demand payment of principal plus
accrued interest upon a specified number of days' notice. Frequently, such
obligations are secured by letters of credit or other credit support
arrangements provided by banks. The issuer of such notes normally has a
corresponding right, after a given period, to repay at its discretion the
outstanding principal of the note plus accrued interest upon a specific number
of days' notice to the bondholders. The interest rate on a demand note may be
based upon a known lending rate, such as the prime lending rate, and be
adjusted when such rate changes, or the interest rate on a demand note may be
a market rate that is adjusted at specified intervals. Each note purchased by
the portfolio will meet the quality criteria set out in the prospectus for the
portfolio.
The yields of municipal bonds depend on, among other things, general money
market conditions, conditions in the municipal bond market, the size of a
particular offering, the maturity of the obligation, and the rating of the
issue. The ratings of Moody's and Standard & Poor's represent their opinions
of the quality of the municipal bonds rated by them. It should be emphasized
that such ratings are general and are not absolute standards of quality.
Consequently, municipal bonds with the same maturity, coupon and rating may
have different yields, while municipal bonds of the same maturity and coupon,
but with different ratings may have the same yield. It will be the
5
<PAGE>
responsibility of the investment management staff to appraise independently
the fundamental quality of the bonds held by the portfolio.
Municipal bonds are sometimes purchased on a "when-issued" basis meaning the
portfolio has committed to purchase certain specified securities at an agreed
upon price when they are issued. The period between commitment date and
issuance date can be a month or more. It is possible that the securities will
never be issued and the commitment canceled.
From time to time proposals have been introduced before Congress to restrict
or eliminate the federal income tax exemption for interest on municipal bonds.
Similar proposals may be introduced in the future. If any such proposal were
enacted, it might restrict or eliminate the ability of the portfolio to
achieve its investment objectives. In that event, the Fund's Trustees and
officers would reevaluate investment objectives and policies and consider
recommending to shareholders changes in such objectives and policies.
Similarly, from time to time proposals have been introduced before state and
local legislatures to restrict or eliminate the state and local income tax
exemption for interest on municipal bonds. Similar proposals may be introduced
in the future. If any such proposal were enacted, it might restrict or
eliminate the ability of a portfolio to achieve its investment objective. In
that event, the Fund's Trustees and officers would reevaluate investment
objectives and policies and consider recommending to shareholders changes in
such objectives and policies.
ZERO COUPON BONDS
Zero Coupon Bonds is a term used to describe notes and bonds which have been
stripped of their unmatured interest coupons, or the coupons themselves, and
also receipts or certificates representing interest in such stripped debt
obligations and coupons. The timely payment of coupon interest and principal
on these instruments remains guaranteed by the issuer.
A Zero Coupon Bond does not pay interest. Instead, it is issued at a
substantial discount to its "face value"--what it will be worth at maturity.
The difference between a security's issue or purchase price and its face value
represents the imputed interest an investor will earn if the security is held
until maturity. For tax purposes, a portion of this imputed interest is deemed
as income received by zero coupon bondholders each year. The Fund, which
expects to qualify as a regulated investment company, intends to pass along
such interest as a component of the portfolio's distributions of net
investment income.
Zero Coupon Bonds may offer investors the opportunity to earn higher yields
than those available on other bonds of similar maturity. However, zero coupon
bond prices may also exhibit greater price volatility than ordinary debt
securities because of the manner in which their principal and interest is
returned to the investor.
Zero Coupon Treasury Bonds are sold under a variety of different names, such
as: Certificate of Accrual on Treasury Securities (CATS), Treasury Receipts
(TRS), Separate Trading of Registered Interest and Principal of Securities
(STRIPS) and Treasury Investment Growth Receipts (TIGERS).
BRADY BONDS
A portion of certain of the Fund's fixed-income investments may be invested in
certain debt obligations customarily referred to as "Brady Bonds", which are
created through the exchange of existing commercial bank loans to foreign
entities for new obligations in connection with debt restructuring under a
plan introduced by former U.S. Secretary of the Treasury, Nicholas F. Brady
(the "Brady Plan").
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Brady Bonds have been issued fairly recently, and, accordingly, do not have a
long payment history. They may be collateralized or uncollateralized and
issued in various currencies (although most are dollar-denominated) and they
are actively traded in the over-the-counter secondary market.
Dollar-denominated, collateralized Brady Bonds, which may be fixed rate par
bonds or floating rate discount bonds, are generally collateralized in full as
to principal due at maturity by U.S. Treasury Zero Coupon Obligations which
have the same maturity as the Brady Bonds. Interest payments on these Brady
Bonds generally are collateralized by cash or securities in an amount that, in
the case of fixed rate bonds, is equal to at least one year of rolling
interest payments or, in the case of floating rate bonds, initially is equal
to at least one year's rolling interest payments based on the applicable
interest rate at that time and is adjusted at regular intervals thereafter.
Certain Brady Bonds are entitled to "value recovery payments" in certain
circumstances, which in effect constitute supplemental interest payments but
generally are not collateralized. Brady Bonds are often viewed as having three
or four valuation components: (i) the collateralized repayment of principal at
final maturity; (ii) the collateralized interest payments; (iii) the
uncollateralized interest payments; and (iv) any uncollateralized repayment of
principal at maturity (these uncollateralized amounts constitute the "residual
risk"). In the event of a default with respect to collateralized Brady Bonds
as a result of which the payment obligations of the issuer are accelerated,
the U.S. Treasury Zero Coupon Obligations held as collateral for the payment
of principal will not be distributed to investors, nor will such obligations
be sold and the proceeds distributed. The collateral will be held by the
collateral agent to the scheduled maturity of the defaulted Brady Bonds, which
will continue to be outstanding, at which time the face amount of the
collateral will equal the principal payments which would have then been due on
the Brady Bonds in the normal course. In addition, in light of the residual
risk of the Brady Bonds and, among other factors, the history of default with
respect to commercial bank loans by public and private entities of countries
issuing Brady Bonds, investments in Brady Bonds are to be viewed as
speculative.
REPURCHASE AGREEMENTS
The portfolio may invest in repurchase agreements collateralized by U.S.
Government securities, certificates of deposit and certain bankers'
acceptances. Repurchase agreements are transactions by which the portfolio
purchases a security and simultaneously commits to resell that security to the
seller (a bank or securities dealer) at an agreed upon price on an agreed upon
date (usually within seven days of purchase). The resale price reflects the
purchase price plus an agreed upon market rate of interest which is unrelated
to the coupon rate or date of maturity of the purchased security. In these
transactions, the securities purchased by the portfolio have a total value in
excess of the value of the repurchase agreement and are held by the
portfolio's custodian bank until repurchased. Such agreements permit the
portfolio to keep all its assets at work while retaining "overnight"
flexibility in pursuit of investments of a longer-term nature. The Adviser and
the Fund's Administrator will continually monitor the value of the underlying
securities to ensure that their value always equals or exceeds the repurchase
price.
The use of repurchase agreements involves certain risks. For example, if the
seller of the agreements defaults on its obligation to repurchase the
underlying securities at a time when the value of these securities has
declined, the portfolio may incur a loss upon disposition of them. If the
seller of the agreement becomes insolvent and subject to liquidation or
reorganization under the Bankruptcy Code or other laws, a bankruptcy court may
determine that the underlying securities are collateral not within the control
of the portfolio and therefore subject to sale by the trustee in bankruptcy.
Finally, it is possible that the portfolio may not be able to substantiate its
interest in the underlying securities. While the Fund's management
acknowledges these risks, it is expected that they can be controlled through
stringent security selection criteria and careful monitoring procedures.
SECURITIES LENDING
The portfolio may lend its investment securities to qualified institutional
investors who need to borrow securities in order to complete certain
transactions, such as covering short sales, avoiding failures to deliver
securities or completing arbitrage operations. By lending its investment
securities, the portfolio attempts to increase its income through the receipt of
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interest on the loan. Any gain or loss in the market price of the securities
loaned that might occur during the term of the loan would be for the account
of the portfolio. The portfolio may lend its investment securities to
qualified brokers, dealers, domestic and foreign banks or other financial
institutions, so long as the terms, the structure and the aggregate amount of
such loans are not inconsistent with the Investment Company Act of 1940 ( the
"1940 Act") or the rules and regulations or interpretations of the Securities
and Exchange Commission (the "SEC") thereunder, which currently require that
(a) the borrower pledge and maintain with the portfolio collateral consisting
of cash, an irrevocable letter of credit issued by a domestic U.S. bank, or
securities issued or guaranteed by the U.S. Government having a value at all
times not less than 100% of the value of the securities loaned, (b) the
borrower add to such collateral whenever the price of the securities loaned
rises (i.e., the borrower "marks to the market" on a daily basis), (c) the
loan be made subject to termination by the portfolio at any time, and (d) the
portfolio receive reasonable interest on the loan (which may include the
portfolio investing any cash collateral in interest bearing short-term
investments), any distribution on the loaned securities and any increase in
their market value. All relevant facts and circumstances, including the
creditworthiness of the broker, dealer or institution, will be considered in
making decisions with respect to the lending of securities, subject to review
by the Trustees.
At the present time, the staff of the SEC does not object if an investment
company pays reasonable negotiated fees in connection with loaned securities,
so long as such fees are set forth in a written contract and approved by the
investment company's Trustees. In addition, voting rights may pass with the
loaned securities, but if a material event were to occur affecting an
investment on loan, the loan must be called and the securities voted.
FOREIGN INVESTMENTS
Investors should recognize that investing in foreign securities involves
certain special considerations which are not typically associated with
investing in domestic securities. Since the securities of foreign issuers are
frequently denominated in foreign currencies, and since the portfolio may
temporarily hold uninvested reserves in bank deposits in foreign currencies,
the portfolio will be affected favorably or unfavorably by changes in currency
rates and in exchange control regulations, and may incur costs in connection
with conversions between various currencies. The investment policies of the
portfolio permit it to enter into forward foreign currency exchange contracts
in order to hedge its respective holdings and commitments against changes in
the level of future currency rates. Such contracts involve an obligation to
purchase or sell a specific currency at a future date at a price set at the
time of the contract.
As non-U.S. companies are not generally subject to uniform accounting,
auditing and financial reporting standards and practices comparable to those
applicable to domestic issuers, there may be less publicly available
information about certain foreign securities than about domestic securities.
Securities of some foreign issuers are generally less liquid and more volatile
than securities of comparable domestic companies. There is generally less
government supervision and regulation of stock exchanges, brokers and listed
issuers than in the U.S. In addition, with respect to certain foreign
countries, there is the possibility of expropriation or confiscatory taxation,
political or social instability, or diplomatic developments which could affect
U.S. investments in those countries.
Although the portfolio will endeavor to achieve most favorable execution costs
in its portfolio transactions, fixed commissions on many foreign stock
exchanges are generally higher than negotiated commissions on U.S. exchanges.
In addition, it is expected that the expenses for custodian arrangements of
the portfolio's foreign securities will be somewhat greater than the expenses
for the custodian arrangements for handling the U.S. securities of equal
value.
Certain foreign governments levy withholding taxes against dividend and
interest income. Although in some countries a portion of these taxes are
recoverable, the non-recovered portion of foreign withholding taxes will
reduce the income received from investments in such countries.
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FUTURES CONTRACTS
Futures contracts provide for the future sale by one party and purchase by
another party of a specified amount of a specific security at a specified
future time and at a specified price. Futures contracts which are standardized
as to maturity date and underlying financial instrument are traded on national
futures exchanges. Futures exchanges and trading are regulated under the
Commodity Exchange Act by the Commodity Futures Trading Commission ("CFTC"), a
U.S. Government agency.
Although futures contracts by their terms call for actual delivery or
acceptance of the underlying securities, in most cases the contracts are
closed out before the settlement date without the making or taking of
delivery. Closing out an open futures position is done by taking an opposite
position ("buying" a contract which has previously been "sold" or "selling" a
contract previously "purchased") in an identical contract to terminate the
position. Brokerage commissions are incurred when a futures contract is bought
or sold.
Futures traders are required to make a good faith margin deposit in cash or
acceptable securities with a broker or custodian to initiate and maintain open
positions in futures contracts. A margin deposit is intended to assure
completion of the contract (delivery or acceptance of the underlying
securities) if it is not terminated prior to the specified delivery date.
Minimum initial margin requirements are established by the futures exchange
and may be changed. Brokers may establish deposit requirements which are
higher than the exchange minimums. Futures contracts are customarily purchased
and sold on the basis of margin deposits that may range upward from less than
5% of the value of the contract being traded. The portfolio's margin deposits
will be placed in a segregated account maintained by the Fund's Custodian or
with a futures commission merchant as approved by the Fund's Board of
Trustees.
After a futures contract position is opened, the value of the contract is
marked to market daily. If the futures contract price changes to the extent
that the margin on deposit does not satisfy margin requirements, payment of
additional "variation" margin will be required. Conversely, a change in the
contract value may reduce the required margin, resulting in a repayment of
excess margin to the contract holder. Variation margin payments are made to
and from the futures broker for as long as the contract remains open. The Fund
expects to earn interest income on its margin deposits.
Traders in futures contracts may be broadly classified as either "hedgers" or
"speculators." Hedgers use the futures markets primarily to offset unfavorable
changes in the value of securities otherwise held for investment purposes or
expected to be acquired by them. Speculators are less inclined to own the
securities underlying the futures contracts which they trade, and use futures
contracts with the expectation of realizing profits from fluctuations in the
value of the underlying securities. Regulations of the CFTC applicable to the
Fund require that the aggregate initial margins and premiums required to
establish non-hedging positions not exceed 5% of the liquidation value of the
portfolio.
Although techniques other than the sale and purchase of futures contracts
could be used to control the portfolio's exposure to market fluctuations, the
use of futures contracts may be a more effective means of hedging this
exposure. While the portfolio will incur commission expenses in both opening
and closing out futures positions, these costs are lower than transaction
costs incurred in the purchase and sale of the underlying securities.
RESTRICTIONS ON THE USE OF FUTURES CONTRACTS
The portfolio may enter into futures contracts and options thereon for both
hedging and non-hedging purposes, provided that not more than 5% of the
portfolio's total assets at the time of entering the transaction are required
as margin and option premiums to secure obligations under such contracts other
than those relating to bona fide hedging activities. It will maintain assets
sufficient to meet its obligations under such contracts in a segregated account
with the custodian bank or will otherwise comply with the Securities and
Exchange Commission's ("SEC's") position on asset coverage.
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RISK FACTORS IN FUTURES TRANSACTIONS
Positions in futures contracts may be closed out only on an exchange which
provides a secondary market for such futures. However, there can be no
assurance that a liquid secondary market will exist for any particular futures
contract at any specific time. Thus, it may not be possible to close a futures
position. In the event of adverse price movements, the portfolio would
continue to be required to make daily cash payments to maintain its required
margin. In such situations, if the portfolio has insufficient cash, it may
have to sell portfolio securities to meet daily margin requirements at a time
when it may be disadvantageous to do so. In addition, the portfolio may be
required to make delivery of the instruments underlying interest rate futures
contracts it holds. The inability to close options and futures positions also
could have an adverse impact on the portfolio's ability to effectively hedge.
The portfolio will minimize the risk that it will be unable to close out a
futures contract by only entering into futures which are traded on national
futures exchanges and for which there appears to be a liquid secondary market.
The risk of loss in trading futures contracts in some strategies can be
substantial, due both to the low margin deposits required and the extremely
high degree of leverage involved in futures pricing. As a result, a relatively
small price movement in a futures contract may result in immediate and
substantial loss (as well as gain) to the investor. For example, if at the
time of purchase, 10% of the value of the futures contract is deposited as
margin, a subsequent 10% decrease in the value of the futures contract would
result in a total loss of the margin deposit, before any deduction for the
transaction costs, if the account were then closed out. A 15% decrease would
result in a loss equal to 150% of the original margin deposit if the contract
were closed out. Thus, a purchase or sale of a futures contract may result in
losses in excess of the amount invested in the contract. The portfolio would
presumably have sustained comparable losses if, instead of the futures
contract, it had invested in the underlying financial instrument and sold it
after the decline.
Utilization of futures transactions by the portfolio does involve the risk of
imperfect or no correlation where the securities underlying futures contracts
have different maturities than the portfolio securities being hedged. It is
also possible that the portfolio could both lose money on futures contracts
and also experience a decline in value of its portfolio securities. There is
also the risk of loss by the portfolio of margin deposits in the event of
bankruptcy of a broker with whom the portfolio has an open position in a
futures contract or related option. Most futures exchanges limit the amount of
fluctuation permitted in 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 a trading session. Once the daily limit has been reached in a
particular type of contract, no trades may be made on that day at a price
beyond that limit. The daily limit governs only price movement during a
particular trading day and therefore does not limit potential losses, because
the limit may prevent the liquidation of unfavorable positions. Futures
contract prices have occasionally moved to the daily limit for several
consecutive trading days with little or no trading, thereby preventing prompt
liquidation of futures positions and subjecting some futures traders to
substantial losses.
OPTIONS
Investments in options involve some of the same considerations that are
involved in connection with investments in futures contracts (e.g., the
existence of a liquid secondary market). In addition, the purchase of an
option also entails the risk that changes in the value of the underlying
security or contract will not be fully reflected in the value of the option
purchased. Depending on the pricing of the option compared to either the
futures contract or securities, an option may or may not be less risky than
ownership of the futures contract or actual securities. In general, the market
prices of options can be expected to be more volatile than the market prices
on the underlying futures contract or securities.
OTC Options are purchased from or sold to securities dealers, financial
institutions or other parties ("Counterparties") through direct bilateral
agreement with the Counterparty. In contrast to exchange listed options, which
generally have standardized terms and performance mechanics, all the terms of
an OTC Option, including such terms as method of settlement, term, exercise
price, premium, guarantees and security, are set by negotiation of the
parties. The portfolio expects generally to enter into OTC Options that have
cash settlement provisions, although it is not required to do so.
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Unless the parties provide for it, there is no central clearing or guaranty
function in an OTC Option. As a result, if the Counterparty fails to make or
take delivery of the security, currency or other instrument underlying an OTC
Option it has entered into with the portfolio or fails to make a cash
settlement payment due in accordance with the terms of that option, the
portfolio will lose any premium it paid for the option as well as any
anticipated benefit of the transaction. Accordingly, the Adviser must assess
the creditworthiness of each such Counterparty or any guarantor of credit
enhancement of the Counterparty's credit to determine the likelihood that the
terms of the OTC Option will be satisfied. The staff of the SEC currently
takes the position that OTC Options purchased by the portfolio or sold by it
(the cost of the sell-back plus the in-the-money amount, if any) are illiquid,
and are subject to the portfolio's limitation on investing in illiquid
securities.
The portfolio may also write covered-call options on foreign currencies for
cross-hedging purposes. A call option on a foreign currency is for
cross-hedging purposes if it is designed to protect against a decline in the
U.S. dollar value of a currency due to the changes of exchange rates vis a vis
the U.S. dollar and the option is written for a currency other than the
currency in which the security is denominated. In such circumstances, the
portfolio will follow the coverage requirements as described in the preceding
paragraph.
OPTIONS ON FOREIGN CURRENCIES
The portfolio may purchase and write options on foreign currencies in a manner
similar to that in which futures contracts on foreign currencies, or forward
contracts, will be utilized. 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 diminution in the value of
portfolio securities, the portfolio may purchase put options on the foreign
currency. If the value of the currency does decline, the portfolio will have
the right to sell such currency for a fixed amount in dollars and will thereby
offset, in whole or in part, the adverse effect on its portfolio which
otherwise would have resulted.
Conversely, where a rise in the dollar value of a currency in which securities
to be acquired are denominated is projected, thereby increasing the cost of
such securities, the portfolio may purchase call options thereon. The purchase
of such options could offset, at least partially, the effects of the adverse
movements in exchange rates. As in the case of other types of options,
however, the benefit to the portfolio derived from purchases of foreign
currency options will be reduced by the amount of the premium and related
transaction costs. In addition, where currency exchange rates do not move in
the direction or to the extent anticipated, the portfolio could sustain losses
on transactions in foreign currency options which would require them to forego
a portion or all of the benefits of advantageous changes in such rates.
The portfolio may write options on foreign currencies for the same purposes.
For example, where the portfolio anticipates a decline in the dollar value of
foreign currency denominated securities due to adverse fluctuations in
exchange rates it could, instead of purchasing a put option, write a call
option on the relevant currency. If the anticipated 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.
Similarly, instead of purchasing a call option to hedge against an anticipated
increase in the dollar cost of securities to be acquired, the portfolio could
write a put option on the relevant currency which, if rates move in the manner
projected, will expire unexercised and allow the portfolio to hedge such
increased cost up to the amount of the premium. As in the case of other types
of options, 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 this does not occur, the option may be exercised
and the portfolio would be required to purchase or sell the underlying
currency at a loss which may not be offset by the amount of the premium.
Through the writing of options on foreign currencies, the portfolio also may
be required to forego all or a portion of the benefits which might otherwise
have been obtained from favorable movements in exchange rates.
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The portfolio may only write covered call options on foreign currencies. A
call option written on a foreign currency by the portfolio is "covered" if the
portfolio owns the underlying foreign currency covered by the call, 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 the Custodian) or upon conversion or exchange of other
foreign currency held in its portfolio. A written call option is also covered
if the portfolio has a call on the same foreign currency and in 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 difference is
maintained by the portfolio in cash or liquid securities in a segregated
account with the Custodian, or (c) maintains in a segregated account cash or
liquid securities in an amount not less than the value of the underlying
foreign currency in U.S. dollars, marked-to-market daily.
The portfolio may also write call options on foreign currencies for
cross-hedging purposes. A call option on a foreign currency is for
cross-hedging purposes if it is designed to provide a hedge against a decline
in the U.S. dollar value of a security which the portfolio owns or has the
right to acquire due to an adverse change in the exchange rate and which is
denominated in the currency underlying the option. In such circumstances, the
portfolio will either "cover" the transaction as described above or
collateralize the option by maintaining in a segregated account with the
Custodian, cash or liquid securities in an amount not less than the value of
the underlying foreign currency in U.S. dollars marked-to-market daily.
COMBINED TRANSACTIONS
The portfolio may enter into multiple transactions, including multiple options
transactions, multiple futures transactions, multiple foreign currency
transactions (including forward foreign currency exchange contracts) and any
combination of futures, options and foreign currency transactions, instead of
a single transaction, as part of a single hedging strategy when, in the
opinion of the Adviser, it is in the best interest of the portfolio to do so.
A combined transaction, while part of a single strategy, may contain elements
of risk that are present in each of its component transactions and will be
structured in accordance with applicable SEC regulations and SEC staff
guidelines.
RISKS OF OPTIONS ON FUTURES CONTRACTS, FORWARD CONTRACTS
AND OPTIONS ON FOREIGN CURRENCIES
Options on foreign currencies and forward contracts are not traded on contract
markets regulated by the CFTC or (with the exception of certain foreign
currency options) by the SEC. To the contrary, such instruments are traded
through financial institutions acting as market-makers, although foreign
currency options are also traded on certain national securities exchanges,
such as the Philadelphia Stock Exchange and the Chicago Board Options
Exchange, subject to SEC regulation. Similarly, options on currencies may be
traded over-the-counter. In an over-the-counter trading environment, many of
the protections afforded to exchange participants will not be available. For
example, there are no daily price fluctuation limits, and adverse market
movements could therefore continue to an unlimited extent over a period of
time. Although the purchase of an option cannot lose more than the amount of
the premium plus related transaction costs, this entire amount could be lost.
Moreover, the option writer and a trader of forward contracts could lose
amounts substantially in excess of their initial investments, due to the
margin and collateral requirements associated with such positions.
Options on foreign currencies traded on national securities exchanges are
within the jurisdiction of the SEC, as are other securities traded on such
exchanges. As a result, many of the protections provided to traders on
organized exchanges will be available with respect to such transactions. In
particular, all foreign currency option positions entered into on a national
securities exchange are cleared and guaranteed by the Options Clearing
Corporation ("OCC"), thereby reducing the risk of counterparty default.
Furthermore, a liquid secondary market in options traded on a national
securities exchange may be more readily available than in the over-the-counter
market, potentially permitting the portfolio to liquidate open positions at a
profit prior to exercise or expiration, or to limit losses in the event of
adverse market movements.
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The purchase and sale of exchange-traded foreign currency options, however, is
subject to the risks of the availability of a liquid secondary market
described above, as well as the risks regarding adverse market movements,
margining of options written, the nature of the foreign currency market,
possible intervention by governmental authorities and the effect of other
political and economic events. In addition, exchange-traded options of foreign
currencies involve certain risks not presented by the over-the-counter market.
For example, exercise and settlement of such options must be made exclusively
through the OCC, which has established banking relationships in applicable
foreign countries for this purpose. As a result, the OCC may, if it determines
that foreign governmental restrictions or taxes would prevent the orderly
settlement of foreign currency option exercises, or would result in undue
burdens on the OCC or its clearing member, impose special procedures on
exercise and settlement, such as technical changes in the mechanics of
delivery of currency, the fixing of dollar settlement prices or prohibitions,
on exercise.
In addition, futures contracts, options on futures contracts, forward
contracts and options on foreign currencies may be traded on foreign
exchanges. Such transactions are subject to the risk of governmental actions
affecting trading in or the prices of foreign currencies or securities. The
value of such positions also could be adversely affected by (i) other complex
foreign political and economic factors, (ii) lesser availability than in the
U.S. of data on which to make trading decisions, (iii) delays in the
portfolio's ability to act upon economic events occurring in foreign markets
during non business hours in the U.S., (iv) the imposition of different
exercise and settlement terms and procedures and margin requirements than in
the U.S., and (v) lesser trading volume.
SWAP CONTRACTS
The portfolio may enter into Swap Contracts. A swap is an agreement to
exchange the return generated by one instrument for the return generated by
another instrument. The payment streams are calculated by reference to a
specified index and agreed upon notional amount. The term "specified index"
includes currencies, fixed interest rates, prices, total return on interest
rate indices, fixed income indices, stock indices and commodity indices (as
well as amounts derived from arithmetic operations on these indices). For
example, the portfolio may agree to swap the return generated by a
fixed-income index for the return generated by a second fixed-income index.
The currency swaps in which the portfolio may enter will generally involve an
agreement to pay interest streams in one currency based on a specified index
in exchange for receiving interest streams denominated in another currency.
Such swaps may involve initial and final exchanges that correspond to the
agreed upon national amount.
The swaps in which the portfolio may engage also include rate caps, floors and
collars under which one party pays a single or periodic fixed amount(s) (or
premium), and the other party pays periodic amounts based on the movement of a
specified index. Swaps do not involve the delivery of securities, other
underlying assets, or principal. Accordingly, the risk of loss with respect to
swaps is limited to the net amount of payments that a portfolio is
contractually obligated to make. If the other party to a swap defaults, a
portfolio's risk of loss consists of the net amount of payments that a
portfolio is contractually entitled to receive. Currency swaps usually involve
the delivery of the entire principal value of one designated currency in
exchange for the other designated currency. Therefore, the entire principal
value of a currency swap is subject to the risk that the other party to the
swap will default on its contractual delivery obligations. If there is a
default by the Counterparty, the portfolio may have contractual remedies
pursuant to the agreements related to the transaction. The swap market has
grown substantially in recent years with a large number of banks and
investment banking firms acting both as principals and as agents utilizing
standardized swap documentation. As a result, the swap market has become
relatively liquid. Caps, floors, and collars are more recent innovations for
which standardized documentation has not yet been fully developed and,
accordingly, they are less liquid than swaps.
The portfolio will usually enter into swaps on a net basis, i.e., the two
payment streams are netted out in a cash settlement on the payment date or
dates specified in the instrument, with the portfolio receiving or paying, as
the case may be, only the net amount of the two payments. The portfolio's
obligations under a swap agreement will be accrued daily (offset against any
amounts owing to the portfolio) and any accrued but unpaid net amounts owed to
a swap Counterparty will be covered by the maintenance of a segregated account
consisting of cash or liquid securities to avoid any potential leveraging of
the portfolio. To the extent that these swaps, caps, floors, and collars are
entered into for hedging purposes, the Adviser believes such obligations do
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not constitute "senior securities" under the 1940 Act and, accordingly, will
not treat them as being subject to the portfolio's borrowing restrictions. The
portfolio may enter into OTC Derivatives transactions (swaps, caps, floors,
puts, etc., but excluding foreign exchange contracts) with Counterparties that
are approved by the Adviser in accordance with guidelines established by the
Board of Trustees. These guidelines provide for a minimum credit rating for
each Counterparty and various credit enhancement techniques (for example,
collateralization of amounts due from Counterparties) to limit exposure to
Counterparties with ratings below AA.
The use of swaps is a highly specialized activity which involves investment
techniques and risks different from those associated with ordinary portfolio
securities transactions. If the Adviser is incorrect in its forecasts of
market values, interest rates, and currency exchange rates, the investment
performance of the portfolio would be less favorable than it would have been
if this investment technique were not used.
FOREIGN CURRENCY EXCHANGE-RELATED SECURITIES
Foreign currency warrants--Foreign currency warrants are warrants which
entitle the holder to receive from the issuer an amount of cash (generally,
for warrants issued in the U.S., in U.S. dollars) which is calculated pursuant
to a predetermined formula and based on the exchange rate between a specified
foreign currency and the U.S. dollar as of the exercise date of the warrant.
Foreign currency warrants generally are exercisable upon their issuance and
expire as of a specified date and time. Foreign currency warrants have been
issued in connection with U.S. dollar-denominated debt offerings by major
corporate issuers in an attempt to reduce the foreign currency exchange risk
which, from the point of view of prospective purchasers of the securities, is
inherent in the international fixed-income marketplace. Foreign currency
warrants may attempt to reduce the foreign exchange risk assumed by purchasers
of a security by, for example, providing for a supplemental payment in the
event that the U.S. dollar depreciates against the value of a major foreign
currency such as the Japanese Yen or German Deutschmark. The formula used to
determine the amount payable upon exercise of a foreign currency warrant may
make the warrant worthless unless the applicable foreign currency exchange
rate moves in a particular direction (e.g., unless the U.S. dollar appreciates
or depreciates against the particular foreign currency to which the warrant is
linked or indexed). Foreign currency warrants are severable from the debt
obligations with which they may be offered, and may be listed on exchanges.
Foreign currency warrants may be exercisable only in certain minimum amounts,
and an investor wishing to exercise warrants who possesses less than the
minimum number required for exercise may be required either to sell the
warrants or to purchase additional warrants, thereby incurring additional
transaction costs. In the case of any exercise of warrants, there may be a
time delay between the time a holder of warrants gives instructions to
exercise and the time the exchange rate relating to exercise is determined,
during which time the exchange rate could change significantly, thereby
affecting both the market and cash settlement values of the warrants being
exercised. The expiration date of the warrants may be accelerated if the
warrants should be delisted from an exchange or if their trading should be
suspended permanently, which would result in the loss of any remaining "time
value" of the warrants (i.e., the difference between the current market value
and the exercise value of the warrants), and, in the case where the warrants
were "out-of-the-money," in a total loss of the purchase price of the
warrants. Warrants are generally unsecured obligations of their issuers and
are not standardized foreign currency options issued by the OCC. Unlike
foreign currency options issued by the OCC, the terms of foreign exchange
warrants generally will not be amended in the event of governmental or
regulatory actions affecting exchange rates or in the event of the imposition
of other regulatory controls affecting the international currency markets. The
initial public offering price of foreign currency warrants is generally
considerably in excess of the price that a commercial user of foreign
currencies might pay in the interbank market for a comparable option involving
significantly larger amounts of foreign currencies. Foreign currency warrants
are subject to complex political or economic factors.
Principal exchange rate linked securities--Principal exchange rate linked
securities are debt obligations the principal on which is payable at maturity
in an amount that may vary based on the exchange rate between the U.S. dollar
and a particular foreign currency at or about that time. The return on
"standard" principal exchange rate linked securities is enhanced if the
foreign currency to which the security is linked appreciates against the U.S.
dollar, and is adversely affected by increases in the foreign exchange value
of the U.S. dollar; "reverse" principal exchange rate linked securities are
like the "standard" securities, except that their return is enhanced by
increases in the value of the U.S. dollar and adversely impacted by increases
in the value of foreign currency. Interest payments on the securities are
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<PAGE>
generally made in U.S. dollars at rates that reflect the degree of foreign
currency risk assumed or given up by the purchaser of the notes (i.e., at
relatively higher interest rates if the purchaser has assumed some of the
foreign exchange risk, or relatively lower interest rates if the issuer has
assumed some of the foreign exchange risk, based of the expectations of the
current market). Principal exchange rate linked securities may in limited
cases be subject to acceleration of maturity (generally, not without the
consent of the holders of the securities), which may have an adverse impact on
the value of the principal payment to be made at maturity.
Performance indexed paper--Performance indexed paper is U.S.
dollar-denominated commercial paper the yield of which is linked to certain
foreign exchange rate movements. The yield to the investor on performance
indexed paper is between the U.S. dollar and a designated currency as of or
about that time (generally, the index maturity two days prior to maturity).
The yield to the investor will be within a range stipulated at the time of
purchase of the obligation, generally with a guaranteed minimum rate of return
that is below, and a potential maximum rate of return that is above, market
yields on U.S. dollar-denominated commercial paper, with both the minimum and
maximum rates of return on the investment corresponding to the minimum and
maximum values of the spot exchange rate two business days prior to maturity.
TAX CONSIDERATIONS
In order for the portfolio to continue to qualify for federal income tax
treatment as a regulated investment company, at least 90% of its gross income
for a taxable year must be derived from qualifying income; i.e., dividends,
interest, income derived from loans of securities, and gains from the sale of
securities or foreign currencies, or other income derived with respect to its
business of investing in such securities or currencies. It is anticipated that
any net gain realized from the closing out of futures contracts will be
considered gain from the sale of securities and therefore be qualifying income
for purposes of the 90% requirement. In addition, (i) the portfolio must
distribute annually to its shareholders at least the sum of 90% of its net
interest income excludable from gross income plus 90% of its investment
company taxable income; (ii) at the close of each quarter of the portfolio's
taxable year, at least 50% of its total assets must be represented by cash and
cash items, vs. government securities, securities of other regulated
investment companies and such other securities with limitations; and (iii) at
the close of each quarter of the portfolio's taxable year, not more than 25%
of the value of its assets may be invested in securities of any one issuer, or
of two or more issuers engaged in same or similar businesses if the portfolio
owns at least 20% of the voting power of such issuers.
The portfolio will distribute to shareholders annually any net capital gains
which have been recognized for federal income tax purposes including
unrealized gains at the end of the portfolio's fiscal year on futures
transactions. Such distributions will be combined with distributions of
capital gains realized on the portfolio's other investments and shareholders
will be advised of the nature of the payments.
The Taxpayer Relief Act of 1997 provides various capital gains rates which
pertain to shareholders who are individuals. The portfolio will, therefore,
designate distributions derived from capital gains of the portfolio (whether
such distributions are paid in cash or additional shares) as a "20% rate gain
distribution" or a "28% rate gain distribution" in accordance with guidance
issued by the Internal Revenue Service. The Fund will notify shareholders
annually as to the federal tax classification of dividends and distributions
paid by the portfolio including, but not limited to notifying individuals as
to the amount of capital gain distributions subject to the 20% and 28% federal
capital gain tax rates. Distributions of dividends or capital gains may also
be subject to state and local taxes.
Some of the options, futures contracts, forward contracts, and swap contracts
entered into by the portfolio may be "Section 1256 contracts." Section 1256
contracts held by the portfolio at the end of its taxable year (and, for
purposes of the 4% excise tax, on certain other dates as prescribed under the
Code) are "marked to market" with unrealized gains or losses treated as though
they were realized. Any gains or losses, including "marked to market" gains or
losses, on Section 1256 contracts other than forward contracts are generally
15
<PAGE>
60% long-term and 40% short-term capital gains or losses ("60/40") although
all foreign currency gains and losses from such contracts may be treated as
ordinary in character absent a special election.
Generally, hedging transactions and certain other transactions in options,
futures, forward contracts and swap contracts undertaken by the portfolio, may
result in "straddles" for U.S. federal income tax purposes. The straddle rules
may affect the character of gain or loss realized by the portfolio. In
addition, losses realized by the portfolio on positions that are part of a
straddle may be deferred under the straddle rules, rather than being taken
into account in calculating the taxable income for the taxable year in which
such losses are realized. Because only a few regulations implementing the
straddle rules have been promulgated, the tax consequences of transactions in
options, futures, forward contracts, and swap agreements to the portfolio are
not entirely clear. The transactions may increase the amount of short-term
capital gain realized by the portfolio. Short-term capital gain is taxed as
ordinary income when distributed to shareholders.
The portfolio may make one or more of the elections available under the Code
which are applicable to straddles. If the portfolio makes any of the
elections, the amount, character, and timing of the recognition of gains or
losses from the affected straddle positions will be determined under rules
that vary according to the elections made. The rules applicable under certain
of the elections operate to accelerate the recognition of gains or losses from
the affected straddle positions.
Because application of the straddle rules may affect the character of gains or
losses, defer losses and/or accelerate the recognition of gains or losses from
the affected straddle positions, the amount which must be distributed to
shareholders, and which will be taxed to shareholders as ordinary income or
long-term capital gain, may be increased or decreased substantially as
compared to the portfolio that did not engage in such hedging transactions.
The Taxpayer Relief Act of 1997 provides constructive sales treatment for
appreciated financial positions such as stock which has increased in value in
the hands of the portfolio. Under this constructive sales treatment, the
portfolio may be treated as having sold such stock and be required to
recognize gain if it enters into a short sale, an offsetting notional
principal contract, a futures or forward contract, or a similar transaction
with respect to such stock or substantially identical property.
The portfolio intends to declare and pay dividends and capital gain
distributions so as to avoid imposition of the federal excise tax. To do so,
the portfolio expects to distribute an amount at least equal to (i) 98% of its
calendar year ordinary income, (ii) 98% of its capital gains net income for
the one-year period ending October 31st, and (iii) 100% of any undistributed
ordinary and capital gain net income from the prior year.
Although, income received on direct U.S. Government obligations is taxable at
the Federal level, such income is exempt from tax at the state level when
received directly, and may be exempt, depending on the state, when received by
a shareholder. The portfolio will inform shareholders annually of the
percentage of income and distributions derived from direct U.S. Government
obligations. Shareholders should consult their tax advisers to determine
whether any portion of dividends received from the portfolio is considered tax
exempt in their particular states.
Any gain or loss recognized on a sale or redemption of shares of the portfolio
by a shareholder who is not a dealer in securities will generally be treated
as long-term capital gain or loss if the shares have been held for more than
eighteen months, mid-term if the shares have been held for over one year but
not for over eighteen months, and short-term if for a year or less. Long-term
capital gains are currently taxed at a maximum rate of 20%; mid-term capital
gains are currently taxed at a maximum rate of 28%; and short-term gains are
currently taxed at ordinary income tax rates. If shares held for six months or
less are sold or redeemed for a loss, two special rules apply: First, if
shares on which a net capital gain distribution has been received are
subsequently sold or redeemed, and such shares have been held for six months
or less, any loss recognized will be treated as long-term capital loss to the
extent of the long-term capital gain distributions. Second, any loss
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<PAGE>
recognized by a shareholder upon the sale or redemption of shares of a
municipal portfolio fund held for six months or less will be disallowed to the
extent of any exempt-interest dividends received by the Shareholder with
respect to such shares.
Foreign Income Taxes: Investment income received by the portfolio from sources
within foreign countries may be subject to foreign income taxes withheld at
the source. The U.S. has entered into Tax Treaties with many foreign countries
which would entitle the portfolio to a reduced rate of tax or exemption from
tax on such income. It is impossible to determine the effective rate of
foreign tax in advance since the amount of the portfolio's assets to be
invested within various countries is not known. The portfolio intends to
operate so as to qualify for treaty-reduced rates of tax where applicable.
PURCHASE OF SHARES
The portfolio reserves the right in its sole discretion (i) to suspend the
offering of its shares (ii) to reject purchase orders, and (iii) to reduce or
waive the minimum for initial and subsequent investments. The officers of the
Fund may from time to time waive the minimum initial and subsequent investment
requirements in connection with investments in the Fund by employees of the
Adviser and its affiliates.
REDEMPTION OF SHARES
The portfolio may suspend redemption privileges or postpone the date of
payment (i) during any period that the New York Stock Exchange ("NYSE") is
closed, or trading on the NYSE is restricted as determined by the SEC, (ii)
during any period when an emergency exists as defined by the rules of the SEC
as a result of which it is not reasonably practicable for the portfolio to
dispose of securities owned by it, or fairly to determine the value of its
assets, and (iii) for such other periods as the SEC may permit.
The Fund has made an election with the SEC pursuant to Rule 18f-1 under the
1940 Act to pay in cash all redemptions requested by any shareholder of record
limited in amount during any 90-day period to the lesser of $250,000 or 1% of
the net assets of the portfolio at the beginning of such period. Such
commitment is irrevocable without the prior approval of the SEC. Redemptions
in excess of the above limits may be paid in whole or in part in investment
securities or in cash, as the Trustees may deem advisable; however, payment
will be made wholly in cash unless the Trustees believe that economic or
market conditions exist which would make such a practice detrimental to the
best interests of the Fund. If redemptions are paid in investment securities,
such securities will be valued as set forth in the Fund's prospectus under
"Valuation of Shares" and a redeeming shareholder would normally incur
brokerage expenses in converting these securities to cash.
No charge is made by the portfolio for redemptions. Redemption proceeds may be
more or less than the shareholder's cost depending on the market value of the
securities held by the portfolio.
TRANSACTIONS WITH BROKER/DEALERS
The Fund has authorized one or more brokers to accept on its behalf purchase
and redemption orders. These brokers are authorized to designate other
intermediaries to accept purchase and redemption orders on the Fund's behalf.
For purposes of determining the purchase price of shares, the Fund will be
deemed to have received a purchase or redemption order when an authorized
broker, or if applicable, a broker's authorized designee, accepts the order.
In other words, orders will be priced at the net asset value net computed
after such orders are accepted by an authorized broker or the broker's
authorized designee.
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<PAGE>
SHAREHOLDER SERVICES
Exchange Privilege
The exchange privilege is only available with respect to the portfolio that is
qualified for sale in a shareholder's state. Exchange requests should be sent
to MAS Funds, c/o Miller Anderson & Sherrerd, LLP, One Tower Bridge, West
Conshohocken, PA 19428-0868. Any such exchange will be based on the respective
net asset values of the shares involved. Before making an exchange, a
shareholder should consider the investment objectives of the portfolio to be
purchased. Exchange requests may be made either by mail or telephone.
Telephone exchanges (referred to as "expedited exchanges") will be accepted
only if the certificates for the shares to be exchanged are held by the Fund
for the account of the shareholder and the registration of the two accounts
are identical. Requests for expedited exchanges received prior to the time at
which the portfolio determines its net asset value, as described in the
prospectus will be processed as of the close of business on the same day.
Requests received after these times will be processed on the next business
day. Expedited exchanges may also be subject to limitations as to amounts or
frequency, and to other restrictions established by the Board of Trustees to
assure that such exchanges do not disadvantage the Fund and its shareholders.
The officers of the Fund reserve the right not to accept any request for an
exchange when, in their opinion, the exchange privilege is being used as a
tool for market timing.
For federal income tax purposes, an exchange between portfolios of the Fund is
a taxable event, and, accordingly, a capital gain or loss may be realized. It
is likely, therefore, that a capital gain or loss would be realized on an
exchange between portfolios; you may want to consult your tax adviser for
further information in this regard. The exchange privilege may be modified or
terminated at any time.
Transfer of Shares
Shareholders may transfer shares of the portfolio to another person by written
request to the Client Services Group at the address noted above. The request
should clearly identify the account and number of shares to be transferred and
include the signature of all registered owners and all share certificates, if
any, which are subject to the transfer. The signature on the letter of
request, the share certificate or any stock power must be guaranteed in the
same manner as described under "Redemption of Shares." As in the case of
redemptions, the written request must be received in good order before any
transfer can be made.
INVESTMENT LIMITATIONS
The portfolio is subject to the following restrictions which are fundamental
policies and may not be changed without the approval of the lesser of: (1) at
least 67% of the voting securities of the portfolio present at a meeting if
the holders of more than 50% of the outstanding voting securities of the
portfolio are present or represented by proxy, or (2) more than 50% of the
outstanding voting securities of the portfolio.
As a matter of fundamental policy, the portfolio will not:
(1) invest in physical commodities or contracts on physical commodities;
(2) purchase or sell real estate, although it may purchase and sell securities
of companies which deal in real estate, other than real estate limited
partnerships, and may purchase and sell marketable securities which are
secured by interests in real estate;
(3) make loans except: (i) by purchasing debt securities in accordance with
its investment objectives and policies, or entering into repurchase
agreements, subject to the limitations described in non-fundamental limitation
(7), below, (ii) by lending its portfolio securities, and (iii) by lending
portfolio assets to other portfolios of the Fund, so long as such loans are
not inconsistent with the 1940 Act, or the rules and regulations, or
interpretations or orders of the SEC thereunder;
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<PAGE>
(4) with respect to 75% of its assets, purchase a security if, as a result, it
would hold more than 10% (taken at the time of such investment) of the
outstanding voting securities of any issuer;
(5) with respect to 75% of its assets, purchase securities of any issuer if,
as a result, more than 5% of the portfolio's total assets, taken at market
value at the time of such investment, would be invested in the securities of
such issuer except that this restriction does not apply to securities issued
or guaranteed by the U.S. Government or its agencies or instrumentalities;
(6) borrow money, except (i) as a temporary measure for extraordinary or
emergency purposes, and (ii) in connection with reverse repurchase agreements,
provided that (i) and (ii) in combination do not exceed 33 1/3% of the
portfolio's total assets (including the amount borrowed) less liabilities
(exclusive of borrowings);
(7) underwrite the securities of other issuers (except to the extent that the
fund may be deemed to be an underwriter within the meaning of the Securities
Act of 1933 in connection with the disposition of restricted securities); and
(8) acquire any securities of companies within one industry, if, as a result
of such acquisition, more than 25% of the value of the portfolio's total
assets would be invested in securities of companies within such industry;
provided, however that (i) there shall be no limitation on the purchase of
obligation issued or guaranteed by the U.S. Government, its agencies or
instrumentalities; (ii) utility companies will be divided according to their
services, for example, gas, gas transmission, electric and telephone will each
be considered a separate industry; (iii) financial service companies will be
classified according to the end users of their services, for example,
automobile finance, bank finance and diversified finance will each be
considered a separate industry; and (v) asset-backed securities will be
classified according to the underlying assets securing such securities.
The portfolio is also subject to the following restrictions which may be
changed by the Board of Trustees without shareholder approval.
As a matter of non-fundamental policy, the portfolio will not:
(1) enter into futures contracts to the extent that the portfolio's
outstanding obligations to purchase securities under these contracts in
combination with its outstanding obligations with respect to options
transactions would exceed 50% of the portfolio's total assets, and will
maintain assets sufficient to meet its obligations under such contracts in a
segregated account with the custodian bank or will otherwise comply with the
SEC's position on asset coverage;
(2) write put or call options except to the extent described above in (1);
(3) purchase on margin, except for use of short-term credit as may be
necessary for the clearance of purchases and sales of securities, provided
that the portfolio may make margin deposits in connection with transactions in
options, futures, and options on futures;
(4) sell short unless, the portfolio (i) by virtue of its ownership of other
securities, has the right to obtain securities equivalent in kind and amount
to the securities sold and, if the right is conditional, the sale is made upon
the same conditions, or (ii) maintains in a segregated account on the books of
the Fund's custodian an amount that, when combined with the amount of
collateral deposited with the broker in connection with the short sale, equals
the current market value of the security sold short or such other amount as
the SEC or its staff may permit by rule, regulation, order or interpretation
(transactions in futures contracts and options, however, are not deemed to
constitute selling securities short);
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(5) borrow money other than from banks or other portfolios of MAS Funds,
provided that the portfolio may borrow from banks or other portfolios of MAS
Funds so long as such borrowing is not inconsistent with the 1940 Act or the
rules, regulations, interpretations or orders of the SEC and its staff
thereunder; or purchase additional securities when borrowings exceed 5% of
total (gross) assets;
(6) pledge, mortgage or hypothecate assets in an amount greater than 50% of
its total assets, provided that the portfolio may segregate assets without
limit in order to comply with the requirements of Section 18(f) of the 1940
Act and applicable rules, regulations or interpretations of the SEC and its
staff;
(7) invest more than an aggregate of 15% of the net assets of the portfolio,
determined at the time of investment, in illiquid securities provided that
this limitation shall not apply to any investment in securities that are not
registered under the 1933 Act but that can be sold to qualified institutional
investors in accordance with Rule 144A under the 1933 Act and are determined
to be liquid securities under guidelines or procedures adopted by the Board of
Trustees;
(8) invest for the purpose of exercising control over management of any company;
and
(9) invest its assets in securities of any investment company, except as
permitted by the 1940 Act or the rules, regulations, interpretations or orders
of the SEC and its staff thereunder.
Excluding the fundamental borrowing limitation as set forth in paragraph (6)
of this section, and unless otherwise indicated, if a percentage limitation on
investment or utilization of assets as set forth above is adhered to at the
time an investment is made, a later change in percentage resulting from
changes in the value or total cost of the portfolio's assets will not be
considered a violation of the restriction, and the sale of securities will not
be required.
MANAGEMENT OF THE FUND
Trustees and Officers
The Fund's officers, under the supervision of the Board of Trustees, manage
the day-to-day operations of the Fund. The Trustees set broad policies for the
Fund and choose its officers. The following is a list of the Trustees and
officers of the Fund and a brief statement of their present positions and
principal occupations during the past 5 years:
Thomas L. Bennett,* Chairman of the Board of Trustees; Managing Director,
Morgan Stanley; Portfolio Manager and member of the Executive Committee,
Miller Anderson & Sherrerd, LLP; Director, MAS Fund Distribution, Inc.;
formerly, Director, Morgan Stanley Universal Funds, Inc.
Thomas P. Gerrity, Trustee; Dean and Reliance Professor of Management and
Private Enterprise, Wharton School of Business , University of Pennsylvania;
Director, Digital Equipment Corp.; Director, Sun Company, Inc.; Director,
Fannie Mae; Director, Reliance Group Holdings; Director, CVS Corporation;
Director, IKON Office Solutions, Inc.; Director, Knight-Ridder, Inc.; formerly,
Director, Union Carbide Corporation.
Joseph P. Healey, Trustee; Headmaster, Haverford School; formerly Dean, Hobart
College; Associate Dean, William & Mary College.
Joseph J. Kearns, Trustee; investment consultant; Chief Investment Officer,
The J. Paul Getty Trust; Director, Electro Rent Corporation; Trustee, Southern
California Edison Nuclear Decommissioning Trust; Director, The Ford Family
Foundation.
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Vincent R. McLean, Trustee; Director, Legal and General America, Inc.;
Director, William Penn Life Insurance Company of New York; formerly Executive
Vice President, Chief Financial Officer, Director and Member of the Executive
Committee of Sperry Corporation (now part of Unisys Corporation).
C. Oscar Morong, Jr., Trustee; Managing Director, Morong Capital Management;
Director, Ministers and Missionaries Benefit Board of American Baptist
Churches, The Indonesia Fund, The Landmark Funds; formerly, Senior Vice
President and Investment Manager for CREF, TIAA-CREF Investment Management,
Inc.
*Trustee Bennett is deemed to be an "interested person" of the Fund as that
term is defined in the 1940 Act.
--------------------------------------------------------------------------
James D. Schmid, President, MAS Funds; Principal, Morgan Stanley; Head of
Mutual Funds, Miller Anderson & Sherrerd, LLP; Director, MAS Fund
Distribution, Inc., Chairman of the Board of Directors, The Minerva Fund,
Inc.; formerly Vice President, The Chase Manhattan Bank.
Lorraine Truten, CFA, Vice President, MAS Funds; Principal, Morgan Stanley;
Head of Mutual Fund Services, Miller Anderson & Sherrerd, LLP; President, MAS
Fund Distribution, Inc.
James Gallo, Treasurer, MAS Funds; Head of Fund Administration, Miller,
Anderson & Sherrerd, LLP; formerly, Manager, Investment Accounting and then
Vice President and Director of Investment Accounting, PFPC, Inc.
John H. Grady, Jr., Secretary, MAS Funds; Partner, Morgan, Lewis & Bockius LLP.
Richard J. Shoch, Assistant Secretary, MAS Funds; Fund Compliance Officer,
Miller, Anderson & Sherrerd, LLP; formerly, Fund Legal Administrator and then
Counsel, Vice President and Assistant Secretary, SEI Corporation.
Remuneration of Trustees and Officers
The Fund pays each Trustee, who is not also an officer or interested person, a
fee for each Board of Trustees Meeting attended plus travel and other expenses
incurred in attending such meetings. Trustees who are also officers or
interested persons receive no remuneration for their service as Trustees. The
Fund's officers and employees are paid by the Adviser or Sub-Administrator.
The Fund maintains an unfunded Deferred Compensation Plan ("Plan") which
allows each independent Trustee to defer payment of his or her retainer and
fees to a later date. The Fund's policy is for each Trustee to defer at least
twenty-five percent (25%) of his or her retainer and fees received annually
from the Fund. To that end, the Plan requires that each Eligible Trustee
(defined by the Plan as a member of the Board of Trustees who is not an
"interested person" of the Fund, as such term is defined under Section
2(a)(19) of the 1940 Act) defer his or her entire retainer, which is deemed a
deferral of twenty-five percent (25%) of the Trustee's retainer and fees
received from the Fund for the year. The Plan also permits the Eligible
Trustee to defer all, or a portion, of the fees received for attending
meetings of the Board of Trustees throughout the year. Amounts deferred by
each Eligible Trustee are credited with a return equal to what those amounts
would have received if they had been invested in portfolios of the Fund
selected by that Trustee. Any deferred amounts will not be available to
Eligible Trustees for a period of three (3) or more years and distributions
may not be deferred beyond the Eligible Trustee's membership on the Board of
Trustees. Distributions to an Eligible Trustee are either in the form of a
lump sum or equal annual installments over a period of five (5) years and
commence within ninety (90) days after the last date during the deferral
period on which the Fund makes a valuation of the Eligible Trustee's deferred
compensation. The Fund intends that the Plan shall be maintained at all times
on an unfunded basis for federal income tax purposes under the Internal
Revenue Code of 1986. The rights of an Eligible Trustee and the beneficiaries
21
<PAGE>
to the amounts held under the Plan are unsecured and such amounts are subject
to the claims of the creditors of the Fund. The Plan became effective May 23,
1996. There were no payments under the Plan during the fiscal year ended
September 30, 1997.
The aggregate compensation paid by the Fund to each of the Trustees during its
fiscal year ended September 30, 1997 is set forth below.
<TABLE>
<CAPTION>
Aggregate Pension or Benefits
Compensation from Accrued as Part of Total Compensation
Name of Trustee the Fund# Fund Expenses from the Fund
- --------------- ------------------ ------------------- ------------------
<S> <C> <C> <C>
Thomas L. Bennett* -0- -0- -0-
Thomas P. Gerrity $57,000## $64,942 $57,000
Joseph P. Healey $57,000## $30,173 $57,000
Joseph J. Kearns $57,000## $60,102 $57,000
C. Oscar Morong, Jr. $57,000## $89,534 $57,000
Vincent R. McLean $57,000## $96,238 $57,000
</TABLE>
*Trustee Bennett is deemed to be an "interested person" of the Fund as that
term is defined in the 1940 Act.
# Includes amounts deferred from quarterly meeting fees at the election of
Trustees under the Deferred Compensation Plan.
## In addition, each Trustee has deferred his retainer of $12,000 under the
Deferred Compensation Plan.
INVESTMENT ADVISER
Under an Investment Advisory Agreement ("Agreement") with the Fund, the
Adviser, subject to the control and supervision of the Fund's Board of
Trustees and in conformance with the stated investment objectives and policies
of the portfolio, manages the investment and reinvestment of the assets of the
portfolio. In this regard, it is the responsibility of the Adviser to make
investment decisions for the portfolio and to place the portfolio's purchase
and sales orders for investment securities.
As compensation for the services rendered by the Adviser under the Agreement
and the assumption by the Adviser of the expenses related thereto (other than
the cost of securities purchased for the portfolio and the taxes and brokerage
commissions, if any, payable in connection with the purchase and/or sale of
such securities), the portfolio pays the Adviser an advisory fee calculated by
applying a quarterly rate, based on the following annual percentage rate, to
the portfolio's average daily net assets for the quarter:
Rate
----
Targeted Duration 0.375%
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In cases where a shareholder of any of the portfolio has an investment
counseling relationship with the Adviser, the Adviser may, at its discretion,
reduce the shareholder's investment counseling fees by an amount equal to the
pro-rata advisory fees paid by the Fund. This procedure will be utilized with
clients having contractual relationships based on total assets managed by
Miller Anderson & Sherrerd, LLP to avoid situations where excess advisory fees
might be paid to the Adviser. In no event will a client pay higher total
advisory fees as a result of the client's investment in the Fund.
The Agreement continues for successive one year periods, only if each renewal
is specifically approved by a vote of the Fund's Board of Trustees, including
the affirmative votes of a majority of the Trustees who are not parties to the
agreement or "interested persons" (as defined in the 1940 Act) of any such
party in person at a meeting called for the purpose of considering such
approval. In addition, the question of continuance of the Agreement may be
presented to the shareholders of the Fund; in such event, continuance shall be
effected only if approved by the affirmative vote of a majority of the
outstanding voting securities of each portfolio of the Fund. If the holders of
any portfolio fail to approve the Agreement, the Adviser may continue to serve
as investment adviser to each portfolio which approved the Agreement, and to
any portfolio which did not approve the Agreement until new arrangements have
been made. The Agreement is automatically terminated if assigned, and may be
terminated by any portfolio without penalty, at any time, (1) by vote of the
Board of Trustees or by vote of the outstanding voting securities of the
portfolio or (2) on sixty (60) days' written notice to the Adviser, or (3) by
the Adviser upon ninety (90) days' written notice to the Fund.
The Fund bears all of its own costs and expenses, including but not limited
to: services of its independent accountants, its administrator and dividend
disbursing and transfer agent, legal counsel, taxes, insurance premiums, costs
incidental to meetings of its shareholders and Trustees, the cost of filing
its registration statements under federal and state securities laws, reports
to shareholders, and custodian fees. These Fund expenses are, in turn,
allocated to each portfolio, based on their relative net assets. The portfolio
bears its own advisory fees and brokerage commissions and transfer taxes in
connection with the acquisition and disposition of its investment securities.
ADMINISTRATION
MAS also serves as Administrator to the Fund pursuant to an Administration
Agreement dated as of November 18, 1993. Chase Global Funds Services Company
(formerly Mutual Fund Services Company, or MFSC), an affiliate of The Chase
Manhattan Bank, serves as transfer agent and provides fund accounting and
other services pursuant to a sub-administration agreement.
DISTRIBUTOR FOR FUND
MAS Fund Distribution, Inc. (the "Distributor"), a wholly-owned subsidiary of
the Adviser, with its principal office at One Tower Bridge, West Conshohocken,
Pennsylvania 19428, distributes the shares of the Fund. Under the Distribution
Agreement, the Distributor, as agent of the Fund, agrees to use its best
efforts as sole distributor of the Fund's shares. The Distribution Agreement
continues in effect so long as such continuance is approved at least annually
by the Fund's Board of Trustees, including a majority of those Trustees who
are not parties to such Distribution Agreement nor interested persons of any
such party. The Distribution Agreement provides that the Fund will bear the
costs of the registration of its shares with the SEC and various states and
the printing of its prospectuses, statements of additional information and
reports to shareholders.
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CUSTODIANS
The Chase Manhattan Bank, New York, NY and Morgan Stanley Trust Company (NY),
Brooklyn, NY serve as custodians for the Fund. The Custodians hold cash,
securities, and other assets of the Fund as required by the 1940 Act. Morgan
Stanley Trust Company is an affiliated person, as defined in the 1940 Act, of
the Adviser and is compensated for its services as custodian on a per account
basis plus out of pocket expenses.
PORTFOLIO TRANSACTIONS
The Investment Advisory Agreement authorizes the Adviser to select the brokers
or dealers that will execute the purchases and sales of investment securities
for the portfolio and directs the Adviser to use its best efforts to obtain
the best execution with respect to all transactions for the portfolio. In so
doing, the Adviser will consider all matters it deems relevant, including the
following: the Adviser's knowledge of negotiated commission rates and spreads
currently available; the nature of the security or instrument being traded;
the size and type of the transaction; the nature and character of the markets
for the security or instrument to be purchased or sold; the desired timing of
the transaction; the activity existing and expected in the market for the
particular security or instrument; confidentiality; the execution, clearance,
and settlement capabilities of the broker or dealer selected and other brokers
or dealers considered; the reputation and perceived soundness of the broker or
dealer selected and other brokers or dealers considered; the Adviser's
knowledge of any actual or apparent operational problems of a broker or
dealer; and the reasonableness of the commission or its equivalent for the
specific transaction.
Although the Adviser generally seeks competitive commission rates and dealer
spreads, the portfolio will not necessarily pay the lowest available
commission on brokerage transactions or markups on principal transactions.
Transactions may involve specialized services on the part of the broker or
dealer involved, and thereby justify higher commissions or markups than would
be the case with other transactions requiring more routine services. In
addition, the portfolio may pay higher commission rates or markups than the
lowest available when the Adviser believes it is reasonable to do so in light
of the value of the research, statistical, pricing, and execution services
provided by the broker or dealer effecting the transaction. The Adviser does
not attempt to put a specific dollar value on the research services rendered
or to allocate the relative costs or benefits of those services among its
clients, believing that the research it receives will help the Adviser to
fulfill its overall duty to its clients. The Adviser uses research services
obtained in this manner for the benefit of all of its clients, though each
particular research service may not be used to service each client. As a
result, the Fund may pay brokerage commissions or markups that are used, in
part, to purchase research services that are not used to benefit the Fund.
It is not the Fund's practice to allocate brokerage or principal business on
the basis of sales of shares which may be made through intermediary brokers or
dealers. However, the Adviser may place portfolio orders with qualified
broker-dealers who recommend the portfolio or who act as agents in the
purchase of shares of the portfolio for their clients. During the fiscal years
ended September 30, 1995, 1996 and 1997, the Fund paid brokerage commissions
of $13,457,075, $18,252,335 and $19,134,219, respectively.
Some securities considered for investment by the portfolio may also be
appropriate for other clients serviced by the Adviser. The Adviser may place a
combined order for two or more accounts or portfolios for the purchase or sale
of the same security if, in its judgment, joint execution is in the best
interest of each participant and will result in best price execution.
Transactions involving commingled orders are allocated in a manner deemed to
be equitable to each account or portfolio. Although it is recognized that, in
some cases, joint execution of orders could adversely affect the price or
volume of the security that a particular account or fund may obtain, it is the
opinion of the Adviser and the Fund's Board of Trustees that combining such
orders generally will be more advantageous to the Fund than effecting such
transactions separately.
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If purchases or sales of securities consistent with the investment policies of
the portfolio and one or more of these other clients serviced by the Adviser
is considered at or about the same time, transactions in such securities will
be allocated among the portfolio and clients in a manner deemed fair and
reasonable by the Adviser. Although there is no specified formula for
allocating such transactions, the various allocation methods used by the
Adviser, and the results of such allocations, are subject to periodic review
by the Fund's Trustees.
On May 31, 1997, Morgan Stanley Group Inc., then the indirect parent of the
Adviser, merged with Dean Witter, Discover & Co. to form Morgan Stanley Dean
Witter & Co. As an indirect subsidiary of Morgan Stanley Dean Witter & Co.,
the Adviser is affiliated with certain U.S.-registered broker-dealers and
foreign broker-dealers (collectively, the AAffiliated Brokers@). The Adviser
may, in the exercise of its discretion under its investment management
agreement, effect transactions in securities or other instruments for the Fund
through the Affiliated Brokers. The Fund paid $132,104 in brokerage
commissions to affiliates for $75,128,827 of brokered transactions for the
fiscal year ended September 30, 1997.
GENERAL INFORMATION
Description of Shares and Voting Rights
The Declaration of Trust permits the Trustees to issue an unlimited number of
shares of beneficial interest, without par value, from an unlimited number of
series ("portfolios") of shares. Currently the Fund is offering shares of
thirty-one portfolios.
The shares of the portfolio are fully paid and non-assessable, except as set
forth below, and have no preference as to conversion, exchange, dividends,
retirement or other features. The shares of the portfolio of the Fund have no
preemptive rights. The shares of the Fund have non-cumulative voting rights,
which means that the holders of more than 50% of the shares voting for the
election of Trustees can elect 100% of the Trustees if they choose to do so. A
shareholder of a class is entitled to one vote for each full class share held
(and a fractional vote for each fractional class share held) in the
shareholder's name on the books of the Fund. Shareholders of a class have
exclusive voting rights regarding any matter submitted to shareholders that
relates solely to that class of shares (such as a distribution plan or service
agreement relating to that class), and separate voting rights on any other
matter submitted to shareholders in which the interests of the shareholders of
that class differ from the interests of holders of any other class.
The Fund will continue without limitation of time, provided however that:
1) Subject to the majority vote of the holders of shares of the portfolio of
the Fund outstanding, the Trustees may sell or convert the assets of such
portfolio to another investment company in exchange for shares of such
investment company, and distribute such shares, ratably among the shareholders
of such portfolio;
2) Subject to the majority vote of shares of the portfolio of the Fund
outstanding, the Trustees may sell and convert into money the assets of such
portfolio and distribute such assets ratably among the shareholders of such
portfolio; and
3) Without the approval of the shareholders of the portfolio, unless otherwise
required by law, the Trustees may combine the assets of any two or more
portfolios into a single portfolio so long as such combination will not have a
material adverse effect upon the shareholders of such portfolio.
Upon completion of the distribution of the remaining proceeds or the remaining
assets of the portfolio as provided in paragraphs 1), 2), and 3) above, that
portfolio shall terminate and the Trustees shall be discharged of any and all
further liabilities and duties hereunder and the right, title and interest of
all parties shall be canceled and discharged with regard to that portfolio.
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Dividends and Distributions
The Fund's policy is to distribute substantially all of the portfolio's net
investment income, if any, together with any net realized capital gains in the
amount and at the times that will avoid both income (including capital gains)
taxes on it and the imposition of the federal excise tax on undistributed
income and capital gains (see discussion under "Dividends, Distributions and
Taxes" in the prospectus). The amounts of any income dividends or capital
gains distributions cannot be predicted.
Any dividend or distribution paid shortly after the purchase of shares of the
portfolio by an investor may have the effect of reducing the per share net
asset value of that portfolio by the per share amount of the dividend or
distribution. Furthermore, such dividends or distributions, although in effect
a return of capital, are subject to income taxes as set forth in the
prospectus.
As set forth in the prospectus, unless the shareholder elects otherwise in
writing, all dividends and distributions are automatically received in
additional shares of the portfolio of the Fund at net asset value (as of the
business day following the record date). This will remain in effect until the
Fund is notified by the shareholder in writing at least three days prior to
the record date that either the Income Option (income dividends in cash and
capital gains distributions in additional shares at net asset value) or the
Cash Option (both income dividends and capital gain distributions in cash) has
been elected. An account statement is sent to shareholders whenever a dividend
or distribution is paid.
The portfolio is treated as a separate entity (and hence, as a separate
"regulated investment company") for federal tax purposes. Any net capital
gains recognized by the portfolio are distributed to its investors without
need to offset (for federal income tax purposes) such gains against any net
capital losses of another portfolio.
Shareholder and Trustee Liability
Under Pennsylvania law, shareholders of a trust such as the Fund may, under
certain circumstances, be held personally liable as partners for the
obligations of the trust. The Fund's Declaration of Trust contains an express
disclaimer of shareholder liability for acts or obligations of the Fund and
requires that notice of such disclaimer be given in each agreement,
obligation, or instrument entered into or executed by the Fund or the
Trustees, but this disclaimer may not be effective in some jurisdictions or as
to certain types of claims. The Declaration of Trust further provides for
indemnification out of the Fund's property of any shareholder held personally
liable for the obligations of the Fund. The Declaration of Trust also provides
that the Fund shall, upon request, assume the defense of any claim made
against any shareholder for any act or obligation of the Fund and satisfy any
judgment thereon. Thus, the risk of a shareholder incurring financial loss on
account of shareholder liability is limited to circumstances in which the Fund
itself would be unable to meet its obligations.
Pursuant to the Declaration of Trust, the Trustees may also authorize the
creation of additional series of shares (the proceeds of which would be
invested in separate, independently managed portfolios with distinct
investment objectives and policies and share purchase, redemption and net
asset valuation procedures) with such preferences, privileges, limitations and
voting and dividend rights as the Trustees may determine. All consideration
received by the Fund for shares of any additional series or class, and all
assets in which such consideration is invested, would belong to that series or
class (subject only to the rights of creditors of the Fund) and would be
subject to the liabilities related thereto. Pursuant to the 1940 Act
shareholders of any additional series or class of shares would normally have
to approve the adoption of any advisory contract relating to such series or
class and of any changes in the investment policies relating thereto.
The Declaration of Trust further provides that the Trustees will not be liable
for errors of judgment or mistakes of fact or law, but nothing in the
Declaration of Trust protects a Trustee against any liability to which he
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would otherwise be subject by reason of willful misfeasance, bad faith, gross
negligence, or reckless disregard of the duties involved in the conduct of the
office.
PERFORMANCE INFORMATION
The Fund may from time to time quote various performance figures to illustrate
the past performance of its portfolios. Performance quotations by investment
companies are subject to rules adopted by the SEC, which require the use of
standardized performance quotations or, alternatively, that every
non-standardized performance quotation furnished by the Fund be accompanied by
certain standardized performance information computed as required by the SEC.
An explanation of the methods for computing performance follows.
Total Return
A portfolio's average annual total return is determined by finding the average
annual compounded rates of return over 1, 5, and 10 year periods (or, if
shorter, the period since inception of the portfolio) that would equate an
initial hypothetical $1,000 investment to its ending redeemable value. The
calculation assumes that all dividends and distributions are reinvested when
paid. The quotation assumes the amount was completely redeemed at the end of
each 1, 5, and 10 year period (or, if shorter, the period since inception of
the portfolio) and the deduction of all applicable Fund expenses on an annual
basis. When considering average total return figures for periods longer than
one year, it is important to note that a portfolio's annual total return for
any one period might have been greater or less than the average for the entire
period. Average annual total return is calculated according to the following
formula:
n
P (1+T) = ERV
Where: P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment
made at the beginning of the stated period
The portfolio may also calculate total return on an aggregate basis which
reflects the cumulative percentage change in value over the measuring period.
Aggregate total returns may be shown by means of schedules, charts or graphs
and may include subtotals of the various components of total return (e.g.
income dividends or returns for specific types of securities such as industry
or country types). The formula for calculating aggregate total return can be
expressed as follows:
Aggregate Total Return = [ ( ERV ) - 1 ]
-----------------------
P
The portfolio may also calculate a total return gross of all expenses which
reflects the cumulative percentage change in value over the measuring period
prior to the deduction of all fund expenses. The formula for calculating the
total return gross of all expenses can be expressed as follows:
Total Return Gross of all Expenses = ((ERV + E)/P) -1)
E = Fund expenses deducted from the ending redeemable value during the
measuring period.
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Yield
In addition to total return, the portfolio may quote performance in terms of a
30-day yield. The yield formula provides for semiannual compounding, which
assumes that net investment income is earned and reinvested at a constant rate
and annualized at the end of a six-month period. Methods used to calculate
advertised yields are standardized for all stock and bond mutual funds.
However, these methods differ from the accounting methods used by the
portfolio to maintain its books and records, therefore the advertised 30-day
yield may not reflect the income paid to your own account or the yield
reported in the portfolio's reports to shareholders. A portfolio may also
advertise or quote a yield which is gross of expenses.
The yield figures provided will be calculated according to a formula
prescribed by the SEC and can be expressed as follows:
6
Yield = 2 [ ( (a-b/cd) + 1) - 1 ]
Where:
a = dividends and interest earned during the period.
b = expenses accrued for the period (net of reimbursements).
c = the average daily number of shares outstanding during the period
that were entitled to receive dividends.
d = the maximum offering price per share on the last day of the period.
For the purpose of determining the interest earned (variable "a" in the
formula) on debt obligations that were purchased by the portfolio at a
discount or premium, the formula generally calls for amortization of the
discount or premium; the amortization schedule will be adjusted monthly to
reflect changes in the market value of the debt obligations.
COMPARATIVE INDEX
The portfolio may from time to time use the following unmanaged index for
performance comparison purposes:
Merrill Lynch 1-3 Year Government Bond Index
FINANCIAL STATEMENTS
The Fund's Financial Statements for the fiscal year ended September 30, 1997,
including notes thereto and the report of PricewaterhouseCoopers LLP thereon are
incorporated herein by reference. A copy of the 1997 Annual Report will
accompany the delivery of this Statement of Additional Information. The
Targeted Duration Portfolio had not commenced operations as of September 30,
1997.
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APPENDIX-DESCRIPTION OF SECURITIES AND RATINGS
I. Description of Bond Ratings
Excerpts from Moody's Investors Service, Inc.'s Corporate Bond Ratings:
Aaa: judged to be the best quality; carry the smallest degree of investment
risk; Aa--judged to be of high quality by all standards; A: possess many
favorable investment attributes and are to be considered as higher medium
grade obligations; Baa: considered as lower medium grade obligations, i.e.,
they are neither highly protected nor poorly secured; Ba: B: protection of
interest and principal payments is questionable.
Caa: Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal
or interest. Ca: Bonds which are rated Ca represent obligations which are
speculative in a high degree. Such issues are often in default or have other
marked shortcomings. C: Bonds which are rated C are lowest rated class of
bonds and issues so rated can be regarded as having extremely poor prospects
of ever attaining any real investment standing.
Note: Moody's may apply numerical modifiers, 1,2 and 3 in each generic rating
classification from Aa through B in its corporate 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 the
modifier 3 indicates that the issue ranks in the lower end of its generic
rating category.
Excerpts from Standard & Poor's Corporation's Corporate Bond Ratings:
AAA: highest grade obligations; possess the ultimate degree of protection as
to principal and interest; AA: also qualify as high grade obligations, and in
the majority of instances differs from AAA issues only in small degree; A:
regarded as upper medium grade; have considerable investment strength but are
not entirely free from adverse effects of changes in economic and trade
conditions. Interest and principal are regarded as safe; BBB: regarded as
borderline between definitely sound obligations and those where the
speculative element begins to predominate; this group is the lowest which
qualifies for commercial bank investments.
BB, B, CCC, CC, C: Debt rated BB, B, CCC, CC and C is regarded, on balance, as
predominantly speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligation. BB indicates the
lowest degree of speculation and C the highest degree of speculation. While
such debt will likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major risk exposures to adverse
conditions. CI: The rating CI is reserved for income bonds on which no
interest is being paid. D: Debt rated D is in payment default. The D rating
category is used when interest payments or principal payments are not made on
the date due even if the applicable grace period has not expired, unless S&P's
believes that such payments will be made during such grace period. The D
rating also will be used upon the filing of a bankruptcy petition if debt
service payments are jeopardized.
Plus(+) or Minus(-): The ratings from "AA" to "CCC" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
Excerpts from Fitch Investors Services, Inc. Corporate Bond Ratings:
AAA: Bonds considered to be investment grade and of the highest credit
quality. The obligor has an exceptionally strong ability to pay interest and
repay principal, which is unlikely to be affected by reasonably foreseeable
events.
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AA: Bonds considered to be investment grade and of very high credit quality.
The obligor's ability to pay interest and repay principal is very strong,
although not quite as strong as bonds rated "AAA". Because bonds rated in the
"AAA" and "AA" categories are not significantly vulnerable to foreseeable
future developments, short term debt of these issuers is generally rated
"-,+".
A: Bonds considered to be investment grade and of high credit quality. The
obligor's ability to pay interest and repay principal is considered to be
strong, but may be more vulnerable to adverse changes in economic conditions
and circumstances than bonds with higher ratings.
BBB: Bonds considered to be investment grade and of satisfactory credit
quality. The obligor's ability to pay interest and repay principal is
considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have adverse impact on these bonds,
and therefore impair timely payment. The likelihood that the ratings of these
bonds will fall below investment grade is higher than for bonds with higher
ratings.
BB: Bonds are considered speculative. The obligor's ability to pay interest
and repay principal may be affected over time by adverse economic changes.
However, business and financial alternatives can be identified which could
assist the obligor in satisfying its debt service requirements.
B: Bonds are considered highly speculative. While bonds in this class are
currently meeting debt service requirements, the probability of continued
timely payment of principal and interest reflects the obligor's limited margin
of safety and the need for reasonable business and economic activity
throughout the life of the issue.
CCC: Bonds have certain identifiable characteristics which, if not remedied,
may lead to default. The ability to meet obligations requires an advantageous
business and economic environment.
CC: Bonds are minimally protected. Default in payment of interest and/or
principal seems probable over time.
C: Bonds are in imminent default in payment of interest or principal.
DDD, DD, and D: Bonds are in default on interest and/or principal payments.
Such bonds are extremely speculative and should be valued on the basis of
their ultimate recovery value in liquidation or reorganization of the obligor.
"DDD" represents the highest potential for recovery on the these bonds, and
"D" represents the lowest potential for recovery.
Plus (+) Minus(-) Plus and minus signs are used with a rating symbol to
indicate the relative position of a credit within the rating category. Plus
and minus signs, however, are not used in the "DDD", "DD", or "D" categories.
Excerpts from Duff & Phelps Corporate Bond Ratings:
AAA: Highest credit quality. The risk factors are negligible, being only
slightly more than for risk-free U.S. Treasury debt.
AA+, AA, AA-: High credit quality. Protection factors are strong. Risk is
modest but may vary slightly from time to time of economic conditions.
A+, A, A-: Protection factors are average but adequate. However, risk factors
are more variable and greater in periods of economic stress.
BBB+,BBB, BBB-: Below average protection factors but still considered
sufficient for prudent investment. Considerable variability in risk during
economic cycles.
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BB+, BB, BB-: Below investment grade but deemed likely to meet obligations
when due. Present or prospective financial protection factors fluctuate
according to industry conditions or company fortunes. Overall quality may move
up or down frequently within this category.
B+, B, B-: Below investment grade and possessing risk that obligations will
not be met when due. Financial protection factors will fluctuate widely
according to economic cycles, industry conditions and/or company fortunes.
Potential exists for frequent changes in the rating within this category or
into a higher or lower rating grade.
CCC: Well below investment grade securities. Considerable uncertainty exists
as to timely payment of principal, interest or preferred dividends.
Protections factors are narrow and risk can be substantial with unfavorable
economic/industry conditions, and/or with unfavorable company developments.
DD: Defaulted debt obligations. Issuer failed to meet scheduled principal
and/or interest payments.
DP: Preferred stock with dividend arrearage.
Description of Bond Ratings
Excerpts from Moody's Investors Service, Inc.'s Preferred Stock Ratings
aaa: An issue which is rated aaa is considered to be a top-quality preferred
stock. This rating indicates good asset protection and the least risk of
dividend impairment within the universe of preferred stocks. aa: An issue
which is rated aa is considered a high-grade preferred stock. This rating
indicates that there is reasonable assurance that earnings and asset
protection will remain relatively well maintained in the foreseeable future.
a: An issue which is rated a is considered to be an upper medium grade
preferred stock. While risks are judged to be somewhat greater than in the aaa
and aa classifications, earnings and asset protection are, nevertheless
expected to be maintained at adequate levels. baa: An issue which is rated baa
is considered to be medium grade, neither highly protected nor poorly secured.
Earnings and asset protection appear adequate at present but may be
questionable over any great length of time. ba: an issue which is rated ba is
considered to have speculative elements and its future cannot be considered
well assured. Earnings and asset protection may be very moderate and not well
safeguarded during adverse periods. Uncertainty of position characterizes
preferred stocks in this class. b: An issue which is rated b generally lacks
the characteristics of a desirable investment. Assurance of dividend payments
and maintenance of other terms of the issue over any long period of time may
be small. caa: An issue which is rated caa is likely to be in arrears on
dividend payments. This rating designation does not purport to indicate the
future status of payment. ca: An issue which is rated ca is speculative in a
high degree an is likely to be in arrears on dividends with little likelihood
of eventual payment. c: This is the lowest rated class of preferred of
preference stock. Issues so rated can be regarded as having extremely poor
prospects of ever attaining any real investment standing.
Note: Moody's may apply numerical modifiers 1,2 and 3 in each rating
classification from "aa "through "b" in its preferred stock rating system. The
modifier 1 indicated that the security ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range raking; and the modifier
3 indicates that the issue ranks in the lower end of its generic rating
category.
Excerpts from Standard & Poor's Corporation's Preferred Stock Ratings
AAA: This is the highest rating that may be assigned by S&P's to a preferred
stock issue and indicates an extremely strong capacity to pay the preferred
stock obligations. AA: A preferred stock issue rated AA also qualifies as a
high quality fixed income security. The capacity to pay preferred stock
obligations is very strong, although not as overwhelming as for issues rated
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AAA. A: An issue rated A is backed by a sound capacity to pay the preferred
stock obligations , although it is somewhat more susceptible to the adverse
effect of the changes in circumstances and economic conditions. BBB: An issue
rated BBB is regarded as backed by an adequate capacity to pay the preferred
stock obligations. Whereas it normally exhibits adequate protection parameter,
adverse economic conditions or changing circumstances are more likely to lead
to a weakened capacity to make payments for a preferred stock in this category
than for issues in the A category. BB,B,CCC: Preferred stock rated BB, B, and
CCC are regarded, on balance, as predominantly speculative with respect to the
issuer's capacity to pay preferred stock obligations. Bb indicates the lowest
degree of speculation and CCC the highest degree of speculation. While such
issues will likely have some quality and protective characteristics, these are
outweighed by large uncertainties of major risk exposures to adverse
conditions. CC: The rating CC is reserved for a preferred stock in arrears on
dividends or sinking fund payments but that is currently paying. C: A
preferred stock rated C is a non-paying issue. D: A preferred stock rated D is
a non-paying issue with the issuer in default on debt instruments.
Plus(+) or Minus(-): The ratings from "AA" for "B" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
Excerpts from Fitch Investors Services, Inc. Preferred Stock Ratings:
AAA: Preferred stocks assigned this rating are the highest quality. Strong
asset protection, conservative balance sheet ratios, and positive indications
of continued protection of preferred dividend requirements are prerequisites
for an "AAA" rating.
AA: Preferred of preference issues assigned this rating are good quality.
Asset protection and coverages of preferred dividends are considered adequate
and are expected to be maintained.
A: Preferred of preference issues assigned this rating are good quality. Asset
protection and coverages of preferred dividends are considered adequate and
are expected to be maintained.
BBB: Preferred or preference issues assigned this rating are reasonably safe
but lack the protections of the "A" to "AAA" categories. Current results
should be watched for possible of deterioration.
BB: Preferred or preference issues assigned this rating are considered
speculative. The margin of protection is slim or subject to wide fluctuations.
The loner-term financial capacities of the enterprises cannot be predicted
with assurance.
B: Issues assigned this rating are considered highly speculative. While
earnings should normally cover dividends, directors may reduce or omit payment
due to unfavorable developments, inability to finance, or wide fluctuations in
earnings.
CCC: Issues assigned this rating are extremely speculative and should be
assessed on their prospects in a possible reorganization. Dividend payments
may be in arrears with the status of the current dividend uncertain.
CC: Dividends are not currently being paid and may be in arrears. The outlook
for future payments cannot be assured.
C: Dividends are not currently being paid and may be in arrears. Prospects for
future payments are remote.
D: Issuer is in default on its debt obligations and has filed for
reorganization or liquidation under the bankruptcy law.
Plus (+) Minus (-) Plus and minus signs are used with a rating symbol to
indicate the relative position of a credit within the rating category. Plus
and minus signs, however, are not used in the "AAA", "CCC", "CC", "C", and "D"
categories.
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