<PAGE>
PROSPECTUS - MAY 1, 1999
Morgan Stanley Dean Witter
CALIFORNIA TAX-FREE INCOME FUND
[COVER PHOTO]
A MUTUAL FUND THAT SEEKS TO PROVIDE A HIGH LEVEL OF
CURRENT
INCOME EXEMPT FROM BOTH FEDERAL AND CALIFORNIA INCOME TAX,
CONSISTENT WITH THE PRESERVATION OF CAPITAL
The Securities and Exchange Commission has not approved or disapproved these
securities or passed upon the adequacy of this PROSPECTUS. Any representation
to the contrary is a criminal offense.
<PAGE>
CONTENTS
<TABLE>
<S> <C> <C>
The Fund Investment Objective........................................ 1
Principal Investment Strategies............................. 1
Principal Risks............................................. 2
Past Performance............................................ 3
Fees and Expenses........................................... 4
Additional Investment Strategy Information.................. 5
Additional Risk Information................................. 6
Fund Management............................................. 7
Shareholder Information Pricing Fund Shares......................................... 8
How to Buy Shares........................................... 8
How to Exchange Shares...................................... 9
How to Sell Shares.......................................... 11
Distributions............................................... 13
Tax Consequences............................................ 13
Share Class Arrangements.................................... 14
Financial Highlights ............................................................ 21
Our Family of Funds ............................................................ Inside Back Cover
THIS PROSPECTUS CONTAINS IMPORTANT INFORMATION ABOUT THE FUND.
PLEASE READ IT CAREFULLY AND KEEP IT FOR FUTURE REFERENCE.
</TABLE>
FUND CATEGORY
---------------------------
/ / Growth
/ / Growth and Income
/X/ INCOME
/ / Money Market
<PAGE>
(Sidebar)
INCOME
An investment objective having the primary goal of selecting securities to pay
out income.
(End Sidebar)
THE FUND
ICON INVESTMENT OBJECTIVE
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Morgan Stanley Dean Witter California Tax-Free Income Fund
is a mutual fund that seeks to provide a high level of
current income exempt from federal and California income
tax, consistent with the preservation of capital. There is
no guarantee that the Fund will achieve this objective.
ICON PRINCIPAL INVESTMENT STRATEGIES
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The Fund will normally invest at least 80% of its assets in
securities that pay interest exempt from federal and
California state income taxes. The Fund's "Investment
Manager," Morgan Stanley Dean Witter Advisors Inc.,
generally invests the Fund's assets in investment grade,
California municipal obligations. Municipal obligations are
bonds, notes or short-term commercial paper issued by state
governments, local governments and their respective
agencies. These municipal obligations will have the
following ratings at the time of purchase:
- municipal bonds -- within the four highest
grades by Moody's
Investors Service Inc.
("Moody's"), Standard &
Poor's Corporation
("S&P"), or Fitch IBCA,
Inc. ("Fitch");
- municipal notes -- within the two highest
grades or, if not rated,
have outstanding bonds
within the four highest
grades by Moody's, S&P or
Fitch; and
- municipal commercial paper -- within the highest grade by
Moody's, S&P or Fitch.
The Fund may also invest in unrated securities which are
judged by the Investment Manager to have comparable quality
to the securities described above.
The Fund may invest up to 20% of its assets in taxable money
market instruments, tax-exempt securities of other states
and municipalities, futures, and securities that pay
interest income subject to the "alternative minimum tax".
Since some investors may have to pay tax on a Fund
distribution of this income, the Fund may not be a suitable
investment for them. See the "Tax Consequences" section for
more details.
Municipal bonds, notes and commercial paper are commonly
classified as either "general obligation" or "revenue."
General obligation bonds, notes, and commercial paper are
secured by the issuer's faith and credit, as well as its
taxing power, for payment of principal and interest. Revenue
bonds, notes and commercial paper, however, are generally
payable from a specific source of income. They are issued to
finance a wide variety of municipal projects which may
include: educational, electric utility, hospital/healthcare,
industrial development/pollution control, single &
multi-family housing, transportation and water & sewer
facilities. Included in the revenue bonds category are
participations in lease obligations. The Fund's municipal
obligation investments may include zero coupon securities,
which are purchased at a discount and make no interest
payments until maturity.
In pursuing the Fund's investment objective, the Investment
Manager has considerable leeway in deciding which
investments it buys, holds or sells on a day-to-day
1
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basis -- and which investment strategies it uses. For
example, the Investment Manager in its discretion may
determine to use some permitted investment strategies while
not using others.
ICON PRINCIPAL RISKS
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The Fund's share price will fluctuate with changes in the
market value of the Fund's portfolio securities. When you
sell Fund shares, they may be worth less than what you paid
for them and, accordingly, you can lose money investing in
this Fund.
CREDIT AND INTEREST RATE RISKS. Principal risks of investing
in the Fund are associated with its municipal investments,
particularly its concentration in municipal obligations of a
single state. Municipal obligations, like other debt
securities, are subject to two types of risks: credit risk
and interest rate risk.
Credit risk refers to the possibility that the issuer of a
security will be unable or unwilling to make interest
payments and/or repay the principal on its debt. In the case
of revenue bonds, notes or commercial paper, for example,
the credit risk is the possibility that the user fees from a
project or other specified revenue sources are insufficient
to meet interest and/or principal payment obligations.
Private activity bonds used to finance such projects in
sectors such as industrial development and pollution control
may also be negatively impacted by the general credit of the
user of the project. Unlike most fixed-income mutual funds,
the Fund is subject to the added credit risk of
concentrating its investments in a single state. The Fund
could be affected by political, economic and regulatory
developments concerning these issuers. Should any
difficulties develop concerning these municipalities'
abilities to pay principal and/or interest on their debt
obligations, the Fund's value and yield could be adversely
affected.
Interest rate risk refers to fluctuations in the value of a
fixed-income security resulting from changes in the general
level of interest rates. When the general level of interest
rates goes up, the prices of most fixed-income securities go
down. When the general level of interest rates goes down,
the prices of most fixed-income securities go up. Zero
coupon securities are typically subject to greater price
fluctuations than comparable securities that pay interest.
As a general illustration of the relationship between
fixed-income securities and interest rates, the following
table shows how interest rates affect bond prices.
<TABLE>
<CAPTION>
PRICE PER $1,000 OF A MUNICIPAL BOND IF
INTEREST RATES:
------------------------------------------
HOW INTEREST RATES AFFECT BOND PRICES INCREASE DECREASE
- -------------------------------------------------- ------------ ----------------
BOND MATURITY COUPON 1% 2% 1% 2%
<S> <C> <C> <C> <C> <C>
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1 Year 1999 3.00% $990 $981 $1,010 $1,020
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5 Years 2003 3.75% $956 $914 $1,046 $1,095
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10 Years 2008 4.10% $922 $852 $1,085 $1,180
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20 Years 2018 4.90% $883 $785 $1,138 $1,302
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30 Years 2028 4.95% $861 $749 $1,175 $1,396
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</TABLE>
Source: MUNICIPAL MARKET DATA ( a division of Thomson
Financial Municipal Group): "Aaa" yield curve as of
12/31/98.
* Assumes no effect from market discount calculation.
** Assumes bonds are non-callable.
2
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(Sidebar)
ANNUAL TOTAL RETURNS
This chart shows how the performance of the Fund's Class B shares has varied
from year to year over the last 10 calendar years.
(End Sidebar)
The Fund is not limited as to the maturities of the
municipal obligations in which it may invest. Thus, a rise
in the general level of interest rates may cause the price
of the Fund's portfolio securities to fall substantially. In
addition, while the Fund may invest in securities with the
lowest investment grade rating. These securities may have
speculative characteristics.
OTHER RISKS. The performance of the Fund also will depend on
whether the Investment Manager is successful in pursuing the
Fund's investment strategy. The Fund is also subject to
other risks from its permissible investments including the
risks associated with its futures and lease obligations
investments.
Shares of the Fund are not bank deposits and are not
guaranteed or insured by any bank, governmental entity, or
the FDIC.
ICON PAST PERFORMANCE
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The bar chart and table below provide some indication of the
risks of investing in the Fund. The Fund's past performance
does not indicate how the Fund will perform in the future.
ANNUAL TOTAL RETURNS - CALENDAR YEARS
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
<TABLE>
<S> <C>
1989 9.54%
'90 5.69%
'91 10.18%
'92 7.83%
'93 10.97%
'94 -5.97%
'95 14.96%
'96 3.13%
'97 7.51%
'98 5.63%
</TABLE>
The bar chart reflects the performance of Class B shares;
the performance of the other Classes will differ because the
Classes have different ongoing fees. The performance
information in the bar chart does not reflect the deduction
of sales charges; if these amounts were reflected, returns
would be less than shown.
During the periods shown in the bar chart, the highest
return for a calendar quarter was 6.11% (quarter ended March
31, 1995) and the lowest return for a calendar quarter was
-5.10% (quarter ended March 31, 1994). Year-to-date total
return as of March 31, 1999 was 0.75%.
3
<PAGE>
(Sidebar)
AVERAGE ANNUAL
TOTAL RETURNS
This table compares the Fund's average annual returns with those of a broad
measure of market performance over time. The Fund's returns include the maximum
applicable sales charge for each Class and assume you sold your shares at the
end of each period.
SHAREHOLDER FEES
These fees are paid directly from your investment.
ANNUAL FUND OPERATING EXPENSES
These expenses are deducted from the Fund's assets and are based on expenses
paid for the fiscal year ended December 31, 1998.
(End Sidebar)
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS (FOR THE PERIOD ENDED THE 1998 CALENDAR YEAR)
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PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS
<S> <C> <C> <C>
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Class A(1) 1.02% -- --
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Class B(1,2) 0.67% 4.51% 6.81%
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Class C(1) 4.23% -- --
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Class D(1) 5.77% -- --
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Lehman Brothers Municipal Bond
Index(2) 6.48% 6.22% 8.22%
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Lipper California Municipal Debt
Funds Index(3) 6.15% 5.81% 7.74%
- -------------------------------------------------------------------------------
</TABLE>
1 The Fund's returns include the maximum applicable sales charge for each
Class and assume you sold your shares at the end of each period.
2 Prior to July 28, 1997, the Fund only issued Class B shares.
3 The Lehman Brothers Municipal Bond Index tracks the performance of
municipal bonds with maturities of two years or more and a minimum credit
rating of Baa or BBB, as measured by Moody's Investors Service or Standard
& Poor's Corp. The Index is unmanaged and should not be considered an
investment.
4 The Lipper California Municipal Debt Funds Index is an equally-weighted
performance index of the largest qualifying funds (based on net assets) in
the Lipper California Municipal Debt Funds objective. The Index, which is
adjusted for capital gains distributions and income dividends, is unmanaged
and should not be considered an investment. There are currently 30 funds
represented in this index.
ICON FEES AND EXPENSES
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The Fund offers four Classes of shares: Classes A, B, C and
D. Each Class has a different combination of fees, expenses
and other features. The table below briefly describes the
fees and expenses that you may pay if you buy and hold
shares of the Fund. The Fund does not charge account or
exchange fees. See the "Share Class Arrangements" section
for further fee and expense information.
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C CLASS D
<S> <C> <C> <C> <C>
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SHAREHOLDER FEES
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Maximum sales charge (load) imposed on
purchases (as a percentage of offering
price) 4.25%(1) None None None
- ---------------------------------------------------------------------------------------
Maximum deferred sales charge (load) (as a
percentage based on the lesser of the
offering price or net asset value at
redemption) None(2) 5.00%(3) 1.00%(4) None
- ---------------------------------------------------------------------------------------
ANNUAL FUND OPERATING EXPENSES
- ---------------------------------------------------------------------------------------
Management fee 0.53% 0.53% 0.53% 0.53%
- ---------------------------------------------------------------------------------------
Distribution and service (12b-1) fees 0.25% 0.75% 0.75% None
- ---------------------------------------------------------------------------------------
Other expenses 0.05% 0.05% 0.05% 0.05%
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Total annual Fund operating expenses 0.83% 1.33% 1.33% 0.58%
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</TABLE>
(1) Reduced for purchases of $25,000 and over.
(2) Investments that are not subject to any sales charge at the time of
purchase are subject to a contingent deferred sales charge ("CDSC") of
1.00% that will be imposed on sales made within one year after purchase,
except for certain specific circumstances.
(3) The CDSC is scaled down to 1.00% during the sixth year, reaching zero
thereafter. See "Share Class Arrangements" for a complete discussion of the
CDSC.
(4) Only applicable to sales made within one year after purchase.
4
<PAGE>
EXAMPLE
This example is intended to help you compare the cost of
investing in the Fund with the cost of investing in other
mutual funds.
The example assumes that you invest $10,000 in the Fund,
your investment has a 5% return each year, and the Fund's
operating expenses remain the same. Although your actual
costs may be higher or lower, the tables below show your
costs at the end of each period based on these assumptions
depending upon whether or not you sell your shares at the
end of each period.
<TABLE>
<CAPTION>
IF YOU SOLD YOUR SHARES: IF YOU HELD YOUR SHARES:
----------------------------------------- -----------------------------------------
1 YEAR 3 YEARS 5 YEARS 10 YEARS 1 YEAR 3 YEARS 5 YEARS 10 YEARS
<S> <C> <C> <C> <C> <C> <C> <C> <C>
- ---------------------------------------------------------- -----------------------------------------
CLASS A $506 $679 $866 $1,407 $506 $679 $866 $1,407
- ---------------------------------------------------------- -----------------------------------------
CLASS B $635 $721 $929 $1,601 $135 $421 $729 $1,601
- ---------------------------------------------------------- -----------------------------------------
CLASS C $235 $421 $729 $1,601 $135 $421 $729 $1,601
- ---------------------------------------------------------- -----------------------------------------
CLASS D $ 59 $186 $324 $ 726 $ 59 $186 $324 $ 726
- ---------------------------------------------------------- -----------------------------------------
</TABLE>
ICON ADDITIONAL INVESTMENT STRATEGY INFORMATION
- --------------------------------------------------------------------------------
The Fund seeks to provide a high level of current income
exempt from federal and California income tax, consistent
with the preservation of capital. There is no guarantee that
the Fund will achieve this objective.
This section provides additional information concerning the
Fund's principal strategies.
The Fund's policy of investing at least 80% of its assets in
securities the interest on which is exempt from federal
income taxes and California state income taxes, except for
"defensive" investing discussed below, is fundamental. This
fundamental policy may not be changed without shareholder
approval.
LEASE OBLIGATIONS. Included within the revenue bonds
category are participations in lease obligations or
installment purchase contracts of municipalities. Generally,
state and local agencies or authorities issue lease
obligations to finance equipment and facilities for public
and private purposes.
FUTURES. The Fund may purchase or sell futures contracts
with respect to financial instruments and municipal bond
indexes. Futures may be used to seek to hedge against
interest rate changes.
DEFENSIVE INVESTING. The Fund may take temporary "defensive"
positions in attempting to respond to adverse market
conditions. The Fund may invest any amount of its assets in
taxable money market securities, non-California tax-exempt
securities or in tax-exempt securities subject to the
alternative minimum tax for individual shareholders when the
Investment Manager believes it is advisable to do so. The
Fund will only purchase municipal obligations of other
states that satisfy the same standards as set forth for the
California tax-exempt securities. Although taking a
defensive posture is designed to protect the Fund from an
anticipated market downturn, it could have the effect of
reducing the Fund's ability to provide California tax-exempt
income.
5
<PAGE>
ICON ADDITIONAL RISK INFORMATION
- --------------------------------------------------------------------------------
This section provides additional information regarding the
principal risks of investing in the Fund.
BOND INSURANCE RISK. Many of the municipal obligations the
Fund invests in will be covered by insurance at the time of
issuance or at a later date. Such insurance covers the
remaining term of the security. Insured municipal
obligations would generally be assigned a lower rating if
the rating were based primarily on the credit quality of the
issuer without regard to the insurance feature. If the
claims-paying ability of the insurer were downgraded, the
ratings on the municipal obligations it insures may also be
downgraded.
LEASE OBLIGATIONS. Lease obligations may have risks not
normally associated with general obligation or other revenue
bonds. Leases and installment purchase or conditional sale
contracts (which may provide for title to the leased asset
to pass eventually to the issuer) have developed in part, as
a means for governmental issuers to acquire property and
equipment without the necessity of complying with the
constitutional and statutory requirements generally
applicable for the issuance of debt. Certain lease
obligations contain "non-appropriation" clauses that provide
that the governmental issuer has no obligation to make
future payments under the lease or contract unless money is
appropriated for that purpose by the appropriate legislative
body on an annual or other periodic basis. Consequently,
continued lease payments on those lease obligations
containing "non-appropriation" clauses are dependent on
future legislative actions. If these legislative actions do
not occur, the holders of the lease obligation may
experience difficulty in exercising their rights, including
disposition of the property.
FUTURES. If the Fund purchases and sells futures contracts,
its participation in these markets would subject the Fund's
portfolio to certain risks. The Investment Manager's
predictions of movements in the direction of interest rate
markets may be inaccurate, and the adverse consequences to
the Fund (e.g., a reduction in the Fund's net asset value or
a reduction in the amount of income available for
distribution) may leave the Fund in a worse position than if
these strategies were not used. Other risks inherent in the
use of futures include, for example, the possible imperfect
correlation between the price of futures contracts and
movements in the prices of the securities being hedged, and
the possible absence of a liquid secondary market for any
particular instrument. The risk of imperfect correlations
may be increased by the fact that futures contracts in which
the Fund may invest are taxable securities rather than
tax-exempt securities. The prices of taxable securities may
not move in a similar manner to prices of tax-exempt
securities.
YEAR 2000. The Fund could be adversely affected if the
computer systems necessary for the efficient operation of
the Investment Manager, the Fund's other service providers
and the markets and individual and governmental issuers in
which the Fund invests do not properly process and calculate
date-related information from and after January 1, 2000.
While year 2000-related computer problems could have a
negative effect on the Fund, the Investment Manager and
affiliates are working hard to avoid any problems and to
obtain assurances from their service providers that they are
taking similar steps.
6
<PAGE>
In addition, it is possible that the markets for securities
in which the Fund invests may be detrimentally affected by
computer failures throughout the financial services industry
beginning January 1, 2000. Improperly functioning trading
systems may result in settlement problems and liquidity
issues. In addition, governmental data processing errors may
result in overall economic uncertainties. Earnings of
individual issuers will be affected by remediation costs,
which may be substantial. Accordingly, the Fund's
investments may be adversely affected.
(Sidebar)
MORGAN STANLEY DEAN WITTER ADVISORS INC.
The Investment Manager is widely recognized as a leader in the mutual fund
industry and together with Morgan Stanley Dean Witter Services Company, Inc.,
its wholly-owned subsidiary, has more than $129 billion in assets under
management or administration as of March 31, 1999.
(End Sidebar)
ICON FUND MANAGEMENT
- --------------------------------------------------------------------------------
The Fund has retained the Investment Manager -- Morgan
Stanley Dean Witter Advisors Inc. -- to provide
administrative services, manage its business affairs and
invest its assets, including the placing of orders for the
purchase and sale of portfolio securities. The Investment
Manager is a wholly-owned subsidiary of Morgan Stanley Dean
Witter & Co., a preeminent global financial services firm
that maintains leading market positions in each of its three
primary businesses: securities, asset management and credit
services. Its main business office is located at Two World
Trade Center, New York, New York 10048.
The Fund's portfolio is managed within the Investment
Manager's Tax-Exempt Group. James F. Willison, a Senior Vice
President of the Investment Manager, has been a primary
portfolio manager of the Fund since its inception. Joseph R.
Arcieri, a Vice President of the Investment Manager, has
been a primary portfolio manager of the Fund since February
1997. Mr. Willison and Mr. Arcieri have been portfolio
managers with the Investment Manager for over five years.
The Fund pays the Investment Manager a monthly management
fee as full compensation for the services and facilities
furnished to the Fund, and for Fund expenses assumed by the
Investment Manager. The fee is based on the Fund's average
daily net assets. For the fiscal year ended December 31,
1998, the Fund accrued total compensation to the Investment
Manager amounting to 0.53% of the Fund's average daily net
assets.
7
<PAGE>
(Sidebar)
CONTACTING A FINANCIAL ADVISOR
If you are new to the Morgan Stanley Dean Witter Family of Funds and would like
to contact a Financial Advisor, call (800) THE-DEAN for the telephone number of
the Morgan Stanley Dean Witter office nearest you. You may also access our
office locator on our Internet site at: www.deanwitter.com/funds
(End Sidebar)
SHAREHOLDER INFORMATION
ICON PRICING FUND SHARES
- --------------------------------------------------------------------------------
The price of Fund shares (excluding sales charges), called
"net asset value," is based on the value of the Fund's
portfolio securities. While the assets of each Class are
invested in a single portfolio of securities, the net asset
value of each Class will differ because the Classes have
different ongoing distribution fees.
The net asset value per share of the Fund is determined once
daily at 4:00 p.m. Eastern time on each day that the New
York Stock Exchange is open (or, on days when the New York
Stock Exchange closes prior to 4:00 p.m., at such earlier
time). Shares will not be priced on days that the New York
Stock Exchange is closed.
The value of the Fund's portfolio securities (except for
short-term taxable debt securities and certain other
investments) are valued by an outside independent pricing
service. The service uses a computerized grid matrix of
tax-exempt securities and its evaluations in determining
what it believes is the fair value of the portfolio
securities. The Fund's Board of Trustees believes that
timely and reliable market quotations are generally not
readily available to the Fund to value tax-exempt securities
and the valuations that the pricing service supplies are
more likely to approximate the fair value of the securities.
An exception to the Fund's general pricing policy concerns
its short-term debt portfolio securities. Debt securities
with remaining maturities of sixty days or less at the time
of purchase are valued at amortized cost. However, if the
cost does not reflect the securities' market value, these
securities will be valued at their fair value.
ICON HOW TO BUY SHARES
- --------------------------------------------------------------------------------
You may open a new account to buy Fund shares or buy
additional Fund shares for an existing account by contacting
your Morgan Stanley Dean Witter Financial Advisor or other
authorized financial representative. Your Financial Advisor
will assist you, step-by-step, with the procedures to invest
in the Fund. You may also purchase shares directly by
calling the Fund's transfer agent and requesting an
application.
Because every investor has different immediate financial
needs and long-term investment goals, the Fund offers
investors four Classes of shares: Classes A, B, C and D.
Class D shares are only offered to a limited group of
investors. Each Class of shares offers a distinct structure
of sales charges, distribution and service fees, and other
features that are designed to address a variety of needs.
Your Financial Advisor or other authorized financial
representative can help you decide which Class may be most
appropriate for you. When purchasing Fund shares, you must
specify which Class of shares you wish to purchase.
When you buy Fund shares, the shares are purchased at the
next share price calculated, less any applicable front-end
sales charge, after we receive your investment order in
proper form. We reserve the right to reject any order for
the purchase of Fund shares.
8
<PAGE>
(Sidebar)
EASYINVEST-SM-
A purchase plan that allows you to transfer money automatically from your
checking or savings account or from a Money Market Fund on a semi-monthly,
monthly or quarterly basis. Contact your Morgan Stanley Dean Witter Financial
Advisor for further information about this service.
(End Sidebar)
<TABLE>
<CAPTION>
MINIMUM INVESTMENT AMOUNTS
- ------------------------------------------------------------------------------------------------
MINIMUM INVESTMENT
----------------------
INVESTMENT OPTIONS INITIAL ADDITIONAL
<S> <C> <C> <C>
- ------------------------------------------------------------------------------------------------
Regular Accounts $ 1,000 $ 100
- ------------------------------------------------------------------------------------------------
EASYINVEST-SM- (automatically from your checking
or savings account or Money Market
Fund) $100* $ 100*
- ------------------------------------------------------------------------------------------------
</TABLE>
* Provided your schedule of investments totals $1,000 in twelve months.
There is no minimum investment amount if you purchase Fund
shares through: (1) the Investment Manager's mutual fund
asset allocation plan, (2) a program, approved by the Fund's
distributor, in which you pay an asset-based fee for
advisory, administrative and/or brokerage services, or (3)
employer-sponsored employee benefit plan accounts.
INVESTMENT OPTIONS FOR CERTAIN INSTITUTIONAL AND OTHER
INVESTORS/CLASS D SHARES. To be eligible to purchase Class D
shares, you must qualify under one of the investor
categories specified in the "Share Class Arrangements"
section of this PROSPECTUS.
THREE DAY SETTLEMENT. Fund shares are sold through the
Fund's distributor. Morgan Stanley Dean Witter Distributors
Inc., on a normal three business day basis; that is, your
payment for Fund shares is due on the third business day
(settlement day) after you place a purchase order.
SUBSEQUENT INVESTMENTS SENT DIRECTLY TO THE FUND. In
addition to buying additional Fund shares for an existing
account by contacting your Morgan Stanley Dean Witter
Financial Advisor, you may send a check directly to the
Fund. To buy additional shares in this manner:
- Write a "letter of instruction" to the Fund specifying the
name(s) on the account, the account number, the social
security or tax identification number, the Class of shares
you wish to purchase and the investment amount (which
would include any applicable front-end sales charge). The
letter must be signed by the account owner(s).
- Make out a check for the total amount payable to: Morgan
Stanley Dean Witter California Tax-Free Income Fund.
- Mail the letter and check to Morgan Stanley Dean Witter
Trust FSB at P.O. Box 1040, Jersey City, NJ 07303.
ICON HOW TO EXCHANGE SHARES
- --------------------------------------------------------------------------------
PERMISSIBLE FUND EXCHANGES. You may exchange shares of any
Class of the Fund for the same Class of any other
continuously offered Multi-Class Fund, or for shares of a
No-Load Fund, Money Market Fund or Short-Term U.S. Treasury
Trust, without the imposition of an exchange fee. See the
inside back cover of this PROSPECTUS for each Morgan Stanley
Dean Witter Fund's designation as a Multi-Class Fund, No-
Load Fund or Money Market Fund. If a Morgan Stanley Dean
Witter Fund is not listed, consult the inside back cover of
that Fund's PROSPECTUS for its designation. For purposes of
exchanges, shares of FSC Funds (subject to a front-end sales
charge) are treated as Class A shares of a Multi-Class Fund.
9
<PAGE>
Exchanges may be made after shares of the Fund acquired by
purchase have been held for thirty days. There is no waiting
period for exchanges of shares acquired by exchange or
dividend reinvestment. The current PROSPECTUS for each fund
describes its investment objective and policies and should
be read before investment.
EXCHANGE PROCEDURES. You can process an exchange by
contacting your Morgan Stanley Dean Witter Financial Advisor
or other authorized financial representative. Otherwise, you
must forward an exchange privilege authorization form to the
Fund's transfer agent - Morgan Stanley Dean Witter Trust FSB
- and then write the transfer agent or call (800) 869-NEWS
to place an exchange order. You can obtain an exchange
privilege authorization form by contacting your Financial
Advisor or other authorized financial representative, or by
calling (800) 869-NEWS. If you hold share certificates, no
exchanges may be processed until we have received all
applicable share certificates.
An exchange to any Morgan Stanley Dean Witter Fund (except a
Money Market Fund) is made on the basis of the next
calculated net asset values of the Funds involved after the
exchange instructions are accepted. When exchanging into a
Money Market Fund, the Fund's shares are sold at their next
calculated net asset value and the Money Market Fund's
shares are purchased at their net asset value on the
following business day.
The Fund may terminate or revise the exchange privilege upon
required notice. Certain services normally available to
shareholders of Money Market Funds, including the check
writing privilege, are not available for Money Market Fund
shares you acquire in an exchange.
TELEPHONE EXCHANGES. For your protection when calling Morgan
Stanley Dean Witter Trust FSB, we will employ reasonable
procedures to confirm that exchange instructions
communicated over the telephone are genuine. These
procedures may include requiring various forms of personal
identification such as name, mailing address, social
security or other tax identification number. Telephone
instructions also may be recorded.
Telephone instructions will be accepted if received by the
Fund's transfer agent between 9:00 a.m. and 4:00 p.m.
Eastern time, on any day the New York Stock Exchange is open
for business. During periods of drastic economic or market
changes, it is possible that the telephone exchange
procedures may be difficult to implement, although this has
not been the case with the Fund in the past.
MARGIN ACCOUNTS. If you have pledged your Fund shares in a
margin account, contact your Morgan Stanley Dean Witter
Financial Advisor or other authorized financial
representative regarding restrictions on the exchange of
such shares.
TAX CONSIDERATIONS OF EXCHANGES. If you exchange shares of
the Fund for shares of another Morgan Stanley Dean Witter
Fund there are important tax considerations. For tax
purposes, the exchange out of the Fund is considered a sale
of Fund shares - and the exchange into the other Fund is
considered a purchase. As a result, you may realize a
capital gain or loss.
You should review the "Tax Consequences" section and consult
your own tax professional about the tax consequences of an
exchange.
FREQUENT EXCHANGES. A pattern of frequent exchanges may
result in the Fund limiting or prohibiting, at its
discretion, additional purchases and/or exchanges. The Fund
will notify you in advance of limiting your exchange
privileges.
10
<PAGE>
CDSC CALCULATIONS ON EXCHANGES. See the "Share Class
Arrangements" section of this PROSPECTUS for a discussion of
how applicable contingent deferred sales charges (CDSCs) are
calculated for shares of one Morgan Stanley Dean Witter Fund
that are exchanged for shares of another.
For further information regarding exchange privileges, you
should contact your Morgan Stanley Dean Witter Financial
Advisor or call (800) 869-NEWS.
ICON HOW TO SELL SHARES
- --------------------------------------------------------------------------------
You can sell some or all of your Fund shares at any time. If
you sell Class A, Class B or Class C shares, your net sale
proceeds are reduced by the amount of any applicable CDSC.
Your shares will be sold at the next share price calculated
after we receive your order to sell as described below.
<TABLE>
<CAPTION>
OPTIONS PROCEDURES
<S> <C>
- --------------------------------------------------------------------------------
Contact your To sell your shares, simply call your Morgan Stanley Dean
Financial Advisor Witter Financial Advisor or other authorized financial
representative.
------------------------------------------------------------
ICON Payment will be sent to the address to which the account is
registered or deposited in your brokerage account.
- --------------------------------------------------------------------------------
By Letter You can also sell your shares by writing a "letter of
instruction" that includes:
ICON - your account number;
- the dollar amount or the number of shares you wish to
sell;
- the Class of shares you wish to sell; and
- the signature of each owner as it appears on the account.
------------------------------------------------------------
If you are requesting payment to anyone other than the
registered owner(s) or that payment be sent to any address
other than the address of the registered owner(s) or
pre-designated bank account, you will need a signature
guarantee. You can obtain a signature guarantee from an
eligible guarantor acceptable to Morgan Stanley Dean Witter
FSB. (You should contact Morgan Stanley Dean Witter Trust
FSB at (800) 869-NEWS for a determination as to whether a
particular institution is an eligible guarantor.) A notary
public CANNOT provide a signature guarantee. Additional
documentation may be required for shares held by a
corporation, partnership, trustee or executor.
------------------------------------------------------------
Mail the letter to Morgan Stanley Dean Witter Trust FSB at
P.O. Box 983, Jersey City, New Jersey 07303. If you hold
share certificates, you must return the certificates, along
with the letter and any required additional documentation.
------------------------------------------------------------
A check will be mailed to the name(s) and address in which
the account is registered, or otherwise according to your
instructions.
- --------------------------------------------------------------------------------
Systematic If your investment in all of the Morgan Stanley Dean Witter
Withdrawal Plan Family of Funds has a total market value of at least
ICON $10,000, you may elect to withdraw amounts of $25 or more,
or in any whole percentage of a Fund's balance (provided the
amount is at least $25), on a monthly, quarterly,
semi-annual or annual basis, from any Fund with a balance of
at least $1,000. Each time you add a Fund to the plan, you
must meet the plan requirements.
------------------------------------------------------------
Amounts withdrawn are subject to any applicable CDSC. A CDSC
may be waived under certain circumstances. See the Class B
waiver categories listed in the "Share Class Arrangements"
section of this PROSPECTUS.
------------------------------------------------------------
To sign up for the Systematic Withdrawal Plan, contact your
Morgan Stanley Dean Witter Financial Advisor or call (800)
869-NEWS. You may terminate or suspend your plan at any
time. Please remember that withdrawals from the plan are
sales of shares, not Fund "distributions," and ultimately
may exhaust your account balance. The Fund may terminate or
revise the plan at any time.
- --------------------------------------------------------------------------------
</TABLE>
11
<PAGE>
PAYMENT FOR SOLD SHARES. After we receive your complete
instructions to sell as described above, a check will be
mailed to you within seven days, although we will attempt to
make payment within one business day. Payment may also be
sent to your brokerage account.
Payment may be postponed or the right to sell your shares
suspended under unusual circumstances. If you request to
sell shares that were recently purchased by check, payment
of the sale proceeds may be delayed for the minimum time
needed to verify that the check has been honored (not more
than fifteen days from the time we receive the check).
REINSTATEMENT PRIVILEGE. If you sell Fund shares and have
not previously exercised the reinstatement privilege, you
may, within 35 days after the date of sale, invest any
portion of the proceeds in the same Class of Fund shares at
their net asset value and receive a pro rata credit for any
CDSC paid in connection with the sale.
INVOLUNTARY SALES. The Fund reserves the right, on sixty
days' notice, to sell the shares of any shareholder (other
than shares held in an IRA or 403(b) Custodial Account)
whose shares, due to sales by the shareholder, have a value
below $100, or in the case of an account opened through
EASYINVEST -SM-, if after 12 months the shareholder has
invested less than $1,000 in the account.
However, before the Fund sells your shares in this manner,
we will notify you and allow you sixty days to make an
additional investment in an amount that will increase the
value of your account to at least the required amount before
the sale is processed. No CDSC will be imposed on any
involuntary sale.
MARGIN ACCOUNTS. Certain restrictions may apply to Fund
shares pledged in margin accounts with Dean Witter Reynolds
or another authorized broker-dealer of Fund shares. If you
hold Fund shares in this manner, please contact your Morgan
Stanley Dean Witter Financial Advisor or other authorized
financial representative for more details.
12
<PAGE>
(Sidebar)
TARGETED DIVIDENDS-SM-
You may select to have your Fund distributions automatically invested in other
Classes of Fund shares or Classes of another Morgan Stanley Dean Witter Fund
that you own. Contact your Morgan Stanley Dean Witter Financial Advisor for
further information about this service.
(End Sidebar)
ICON DISTRIBUTIONS
- --------------------------------------------------------------------------------
The Fund passes substantially all of its earnings from
income and capital gains along to its investors as
"distributions." The Fund earns interest from fixed-income
investments. These amounts are passed along to Fund
shareholders as "income dividend distributions." The Fund
realizes capital gains whenever it sells securities for a
higher price than it paid for them. These amounts may be
passed along as "capital gain distributions."
The Fund declares income dividends separately for each
Class. Distributions paid on Class A and Class D shares will
be higher than for Class B and Class C because distribution
fees that Class B and Class C pay are higher. Normally,
income dividends are declared on each day the New York Stock
Exchange is open for business, and are distributed to
shareholders monthly, and capital gains are distributed at
least annually in December. The Fund, however, may retain
and reinvest any long-term capital gains. The Fund may at
times make payments from sources other than income or
capital gains that represent a return of a portion of your
investment.
Distributions are reinvested automatically in additional
shares of the same Class and automatically credited to your
account, unless you request in writing that all
distributions be paid in cash. If you elect the cash option,
the Fund will mail a check to you no later than seven
business days after the distribution is declared. No
interest will accrue on uncashed checks. If you wish to
change how your distributions are paid, your request should
be received by the Fund's transfer agent, Morgan Stanley
Dean Witter Trust FSB, at least five business days prior to
the record date of the distributions.
ICON TAX CONSEQUENCES
- --------------------------------------------------------------------------------
As with any investment, you should consider how your Fund
investment will be taxed. The tax information in this
PROSPECTUS is provided as general information. You should
consult your own tax professional about the tax consequences
of an investment in the Fund.
You need to be aware of the possible tax consequences when:
- The Fund makes distributions; and
- You sell Fund shares, including an exchange to another
Morgan Stanley Dean Witter Fund.
TAXES ON DISTRIBUTIONS. Your income dividend distributions
are normally exempt from federal and California's personal
income taxes -- to the extent they are derived from
California's municipal obligations. Income derived from
other portfolio securities may be subject to federal, state
and/or local income taxes.
Income derived from some municipal securities is subject to
the federal "alternative minimum tax." Certain tax-exempt
securities whose proceeds are used to finance private,
for-profit organizations are subject to this special tax
system that ensures
13
<PAGE>
that individuals pay at least some federal taxes. Although
interest on these securities is generally exempt from
federal income tax, some taxpayers who have many tax
deductions or exemptions nevertheless may have to pay tax on
the income.
If you borrow money to purchase shares of the Fund, the
interest on the borrowed money is generally not deductible
for personal income tax purposes.
If the Fund makes any capital gain distributions, those
distributions will normally be subject to federal and
California income tax when they are paid, whether you take
them in cash or reinvest them in the Fund shares. Any
long-term capital gain distributions are taxable to you as
long-term capital gains, no matter how long you have owned
shares in the Fund.
The Fund may derive gains in part from municipal obligations
the Fund purchased below their principal or face values.
All, or a portion, of these gains may be taxable to you as
ordinary income rather than capital gains.
Every January, you will be sent a statement (IRS Form
1099-DIV) showing the taxable distributions paid to you in
the previous year. The statement provides full information
on your dividends and capital gains for tax purposes.
TAXES ON SALES. Your sale of Fund shares normally is subject
to federal and state income tax and may result in a taxable
gain or loss to you. A sale also may be subject to local
income tax. Your exchange of Fund shares for shares of
another Morgan Stanley Dean Witter Fund is treated for tax
purposes like a sale of your original shares and a purchase
of your new shares. Thus, the exchange may, like a sale,
result in a taxable gain or loss to you and will give you a
new tax basis for your new shares.
When you open your Fund account, you should provide your
social security or tax identification number on your
investment application. By providing this information, you
will avoid being subject to a federal backup withholding tax
of 31% on taxable distributions and redemption proceeds. Any
withheld amount would be sent to the IRS as an advance tax
payment.
ICON SHARE CLASS ARRANGEMENTS
- --------------------------------------------------------------------------------
The Fund offers several Classes of shares having different
distribution arrangements designed to provide you with
different purchase options according to your investment
needs. Your Morgan Stanley Dean Witter Financial Advisor or
other authorized financial representative can help you
decide which Class may be appropriate for you.
The general public is offered three Classes: Class A shares,
Class B shares and Class C shares, which differ principally
in terms of sales charges and ongoing expenses. A fourth
Class, Class D shares, is offered only to a limited category
of investors. Shares that you acquire through reinvested
distributions will not be subject to any front-end sales
charge or CDSC - contingent deferred sales charge. Sales
Personnel may receive different compensation for selling
each Class of shares. The sales charges applicable to each
Class provide for the distribution financing of shares of
that Class.
14
<PAGE>
(SIDEBAR)
FRONT-END SALES CHARGE OR FSC
An initial sales charge you pay when purchasing Class A shares that is based on
a percentage of the offering price. The percentage declines based upon the
dollar value of Class A shares you purchase. We offer three ways to reduce your
Class A sales charges - the COMBINED PURCHASE PRIVILEGE, RIGHT OF ACCUMULATION
and LETTER OF INTENT.
(End Sidebar)
The chart below compares the sales charge and annual 12b-1
fee applicable to each Class:
<TABLE>
<CAPTION>
CLASS SALES CHARGE ANNUAL 12b-1 FEE
<S> <C> <C>
- ------------------------------------------------------------------
A Maximum 4.25% initial sales charge
reduced for purchase of $25,000 or more;
shares sold without an initial sales
charge are generally subject to a 1.0%
CDSC during the first year 0.25%
- ------------------------------------------------------------------
B Maximum 5.0% CDSC during the first year
decreasing to 0% after six years 0.75%
- ------------------------------------------------------------------
C 1.0% CDSC during the first year 0.75%
- ------------------------------------------------------------------
D None None
- ------------------------------------------------------------------
</TABLE>
CLASS A SHARES Class A shares are sold at net asset value
plus an initial sales charge of up to 4.25%. The initial
sales charge is reduced for purchases of $25,000 or more
according to the schedule below. Investments of $1 million
or more are not subject to an initial sales charge, but are
generally subject to a contingent deferred sales charge, or
CDSC, of 1.0% on sales made within one year after the last
day of the month of purchase. The CDSC will be assessed in
the same manner and with the same CDSC waivers as with Class
B shares. Class A shares are also subject to a distribution
(12b-1) fee of up to 0.25% of the average daily net assets
of the Class.
The offering price of Class A shares includes a sales charge
(expressed as a percentage of the offering price) on a
single transaction as shown in the following table:
<TABLE>
<CAPTION>
FRONT-END SALES CHARGE
----------------------------------------------
PERCENTAGE OF APPROXIMATE PERCENTAGE
AMOUNT OF SINGLE TRANSACTION PUBLIC OFFERING PRICE OF AMOUNT INVESTED
<S> <C> <C>
- ----------------------------------------------------------------------------------------
Less than $25,000 4.25% 4.44%
- ----------------------------------------------------------------------------------------
$25,000 but less than $50,000 4.00% 4.17%
- ----------------------------------------------------------------------------------------
$50,000 but less than $100,000 3.50% 3.63%
- ----------------------------------------------------------------------------------------
$100,000 but less than $250,000 2.75% 2.83%
- ----------------------------------------------------------------------------------------
$250,000 but less than $1 million 1.75% 1.78%
- ----------------------------------------------------------------------------------------
$1 million and over 0 0
- ----------------------------------------------------------------------------------------
</TABLE>
The reduced sales charge schedule is applicable to purchases
of Class A shares in a single transaction by:
- A single account (including an individual, trust or
fiduciary account).
- Family member accounts (limited to husband, wife and
children under the age of 21).
- Pension, profit sharing or other employee benefit plans of
companies and their affiliates.
- Tax-exempt organizations.
- Groups organized for a purpose other than to buy mutual
fund shares.
15
<PAGE>
COMBINED PURCHASE PRIVILEGE. You also will have the benefit
of reduced sales charges by combining purchases of Class A
shares of the Fund in a single transaction with purchases of
Class A shares of other Multi-Class Funds and shares of FSC
Funds.
RIGHT OF ACCUMULATION. You also may benefit from a reduction
of sales charges if the cumulative net asset value of Class
A shares of the Fund purchased in a single transaction,
together with shares of other Funds you currently own which
were previously purchased at a price including a front-end
sales charge (including shares acquired through reinvestment
of distributions), amounts to $25,000 or more. Also, if you
have a cumulative net asset value of all your Class A and
Class D shares equal to at least $5 million (or $25 million
for certain employee benefit plans), you are eligible to
purchase Class D shares of any Fund subject to the Fund's
minimum initial investment requirement.
You must notify your Morgan Stanley Dean Witter Financial
Advisor or other authorized financial representative (or
Morgan Stanley Dean Witter Trust FSB if you purchase
directly through the Fund), at the time a purchase order is
placed, that the purchase qualifies for the reduced charge
under the Right of Accumulation. Similar notification must
be made in writing when an order is placed by mail. The
reduced sales charge will not be granted if: (i)
notification is not furnished at the time of the order; or
(ii) a review of the records of Dean Witter Reynolds or
other authorized dealer of Fund shares or the Fund's
transfer agent does not confirm your represented holdings.
LETTER OF INTENT. The schedule of reduced sales charges for
larger purchases also will be available to you if you enter
into a written "letter of intent." A letter of intent
provides for the purchase of shares within a thirteen-month
period. It is available for purchases of Class A shares of
Multi-Class Funds and/or shares of FSC Funds. The initial
purchase under a letter of intent must be at least 5% of the
stated investment goal. To determine the applicable sales
charge reduction, you may also include: (1) the cost of
shares of other Morgan Stanley Dean Witter Funds which were
previously purchased at a price including a front-end sales
charge during the 90-day period prior to the distributor
receiving the letter of intent, and (2) the cost of shares
of other Funds you currently own acquired in exchange for
shares of Funds purchased during that period at a price
including a front-end sales charge. You can obtain a letter
of intent by contacting your Morgan Stanley Dean Witter
Financial Advisor or other authorized financial
representative, or by calling (800) 869-NEWS. If you do not
achieve the stated investment goal within the thirteen-month
period, you are required to pay the difference between the
sales charges otherwise applicable and sales charges
actually paid.
OTHER FRONT-END SALES CHARGE WAIVERS. In addition to
investments of $1 million or more, your purchase of Class A
shares is not subject to a front-end sales charge (or a CDSC
upon sale) if your account qualifies under one of the
following categories:
- A trust for which Morgan Stanley Dean Witter Trust FSB
provides discretionary trustee services.
16
<PAGE>
(Sidebar)
CONTINGENT DEFERRED SALES CHARGE OR CDSC
A fee you pay when you sell shares of certain Morgan Stanley Dean Witter Funds
purchased without an initial sales charge. This fee declines the longer you hold
your shares as set forth in the table.
(End Sidebar)
- Persons participating in a fee-based investment program
(subject to all of its terms and conditions, including
mandatory sale or transfer restrictions on termination)
approved by the Fund's distributor pursuant to which they
pay an asset-based fee for investment advisory,
administrative and/or brokerage services.
- A client of a Morgan Stanley Dean Witter Financial Advisor
who joined us from another investment firm within six
months prior to the date of purchase of Fund shares, and
used the proceeds from the sale of shares of a proprietary
mutual fund of that Financial Advisor's previous firm that
imposed either a front-end or deferred sales charge to
purchase Class A shares, provided that: (1) you sold the
shares not more than 60 days prior to purchase, and (2)
the sale proceeds were maintained in the interim in cash
or a money market fund.
- Current or retired Directors/Trustees of the Morgan
Stanley Dean Witter Funds, such persons' spouses and
children under the age of 21, and trust accounts for which
any of such persons is a beneficiary.
- Current or retired directors, officers and employees of
Morgan Stanley Dean Witter & Co. and any of its
subsidiaries, such persons' spouses and children under the
age of 21, and trust accounts for which any of such
persons is a beneficiary.
CLASS B SHARES Class B shares are offered at net asset
value with no initial sales charge but are subject to a
contingent deferred sales charge, or CDSC, as set forth in
the table below. For the purpose of calculating the CDSC,
shares are deemed to have been purchased on the last day of
the month during which they were purchased.
<TABLE>
<CAPTION>
YEAR SINCE PURCHASE PAYMENT MADE CDSC AS A PERCENTAGE OF AMOUNT REDEEMED
<S> <C>
- ---------------------------------------------------------------------------------
First 5.0%
- ---------------------------------------------------------------------------------
Second 4.0%
- ---------------------------------------------------------------------------------
Third 3.0%
- ---------------------------------------------------------------------------------
Fourth 2.0%
- ---------------------------------------------------------------------------------
Fifth 2.0%
- ---------------------------------------------------------------------------------
Sixth 1.0%
- ---------------------------------------------------------------------------------
Seventh and thereafter None
- ---------------------------------------------------------------------------------
</TABLE>
Each time you place an order to sell or exchange shares,
shares with no CDSC will be sold or exchanged first, then
shares with the lowest CDSC will be sold or exchanged next.
For any shares subject to a CDSC, the CDSC will be assessed
on an amount equal to the lesser of the current market value
or the cost of the shares being sold.
CDSC WAIVERS. A CDSC, if otherwise applicable, will be
waived in the case of:
- Sales of shares held at the time you die or become
disabled (within the definition in Section 72(m)(7) of the
Internal Revenue Code which relates to the ability to
engage in gainful employment), if the shares are: (i)
registered either in your name (not a trust) or in the
names of you and your spouse as joint tenants with right
of survivorship; or (ii) held in a qualified corporate or
self-employed
17
<PAGE>
retirement plan, IRA or 403(b) Custodial Account, provided
in either case that the sale is requested within one year
of your death or initial determination of disability.
- Sales in connection with the following retirement plan
"distributions": (i) lump-sum or other distributions from
a qualified corporate or self-employed retirement plan
following retirement (or, in the case of a "key employee"
of a "top heavy" plan, following attainment of age 59
1/2); (ii) distributions from an IRA or 403(b) Custodial
Account following attainment of age 59 1/2; or (iii) a
tax-free return of an excess IRA contribution (a
"distribution" does not include a direct transfer of IRA,
403(b) Custodial Account or retirement plan assets to a
successor custodian or trustee).
- Sales of shares in connection with the Systematic
Withdrawal Plan of up to 12% annually of the value of each
Fund from which plan sales are made. The percentage is
determined on the date you establish the Systematic
Withdrawal Plan and based on the next calculated share
price. You may have this CDSC waiver applied in amounts up
to 1% per month, 3% per quarter, 6% semi-annually or 12%
annually. Shares with no CDSC will be sold first, followed
by those with the lowest CDSC. As such, the waiver benefit
will be reduced by the amount of your shares that are not
subject to a CDSC. If you suspend your participation in
the plan, you may later resume plan payments without
requiring a new determination of the account value for the
12% CDSC waiver.
All waivers will be granted only following the Distributor
receiving confirmation of your entitlement. If you believe
you are eligible for a CDSC waiver, please contact your
Financial Advisor or call (800) 869-NEWS.
DISTRIBUTION FEE. Class B shares are also subject to an
annual distribution (12b-1) fee of up to 0.75% of the lesser
of: (a) the average daily aggregate gross purchases by all
shareholders of the Fund's Class B shares since the
inception of the Fund (not including reinvestment of
dividends or capital gains distributions), less the average
daily aggregate net asset value of the Fund's Class B shares
sold by all shareholders since the Fund's inception upon
which a CDSC has been imposed or waived, or (b) the average
daily net assets of Class B.
CONVERSION FEATURE. After ten (10) years, Class B shares
will convert automatically to Class A shares of the Fund
with no initial sales charge. The ten year period runs from
the last day of the month in which the shares were
purchased, or in the case of Class B shares acquired through
an exchange, from the last day of the month in which the
original Class B shares were purchased; the shares will
convert to Class A shares based on their relative net asset
values in the month following the ten year period. At the
same time, an equal proportion of Class B shares acquired
through automatically reinvested distributions will convert
to Class A shares on the same basis. (Class B shares held
before May 1, 1997, however, will convert to Class A shares
in May 2007.)
Currently, the Class B share conversion is not a taxable
event; the conversion feature may be cancelled if it is
deemed a taxable event in the future by the Internal Revenue
Service.
18
<PAGE>
If you exchange your Class B shares for shares of a Money
Market Fund, No-Load Fund or Short-Term U.S. Treasury Trust,
the holding period for conversion is frozen as of the last
day of the month of the exchange and resumes on the last day
of the month you exchange back into Class B shares.
EXCHANGING SHARES SUBJECT TO A CDSC. There are special
considerations when you exchange Fund shares that are
subject to a CDSC. When determining the length of time you
held the shares and the corresponding CDSC rate, any period
(starting at the end of the month) during which you held
shares of a fund that does NOT charge a CDSC WILL NOT BE
COUNTED. Thus, in effect the "holding period" for purposes
of calculating the CDSC is frozen upon exchanging into a
fund that does not charge a CDSC.
For example, if you held Class B shares of the Fund for one
year, exchanged to Class B of another Morgan Stanley Dean
Witter Multi-Class Fund for another year, then sold your
shares, a CDSC rate of 4% would be imposed on the shares
based on a two year holding period -- one year for each
Fund. However, if you had exchanged the shares of the Fund
for a Money Market Fund (which does not charge a CDSC)
instead of the Multi-Class Fund, then sold your shares, a
CDSC rate of 5% would be imposed on the shares based on a
one year holding period. The one year in the Money Market
Fund would not be counted. Nevertheless, if shares subject
to a CDSC are exchanged for a Fund that does not charge a
CDSC, you will receive a credit when you sell the shares
equal to the distribution (12b-1) fees you paid on those
shares while in that Fund up to the amount of any applicable
CDSC.
In addition, shares that are exchanged into or from a Morgan
Stanley Dean Witter Fund subject to a higher CDSC rate will
be subject to the higher rate, even if the shares are
re-exchanged into a Fund with a lower CDSC rate.
CLASS C SHARES Class C shares are sold at net asset value
with no initial sales charge but are subject to a CDSC of
1.0% on sales made within one year after the last day of the
month of purchase. The CDSC will be assessed in the same
manner and with the same CDSC waivers as with Class B
shares.
DISTRIBUTION FEE. Class C shares are subject to an annual
distribution (12b-1) fee of 0.75% of the average daily net
assets of that Class. The Class C shares' distribution fee
may cause that Class to have higher expenses and pay lower
dividends than Class A or Class D shares. Unlike Class B
shares, Class C shares have no conversion feature and,
accordingly, an investor that purchases Class C shares may
be subject to distribution (12b-1) fees applicable to Class
C shares for an indefinite period.
19
<PAGE>
CLASS D SHARES Class D shares are offered without any
sales charge on purchases or sales and without any
distribution (12b-1) fee. Class D shares are offered only to
investors meeting an initial investment minimum of $5
million and the following investor categories:
- Investors participating in the Investment Manager's mutual
fund asset allocation program (subject to all of its terms
and conditions, including mandatory sale or transfer
restrictions on termination) pursuant to which they pay an
asset-based fee.
- Persons participating in a fee-based investment program
(subject to all of its terms and conditions, including
mandatory sale or transfer restrictions on termination)
approved by the Fund's distributor pursuant to which they
pay an asset-based fee for investment advisory,
administrative and/or brokerage services.
- Certain unit investment trusts sponsored by Dean Witter
Reynolds.
- Certain other open-end investment companies whose shares
are distributed by the Fund's distributor.
- Investors who were shareholders of the Dean Witter
Retirement Series on September 11, 1998 for additional
purchases for their former Dean Witter Retirement Series
accounts.
MEETING CLASS D ELIGIBILITY MINIMUMS. To meet the $5 million
initial investment to qualify to purchase Class D shares you
may combine: (1) purchases in a single transaction of Class
D shares of the Fund and other Morgan Stanley Dean Witter
Multi-Class Funds and/or (2) previous purchases of Class A
and Class D shares of Multi-Class Funds and shares of FSC
Funds you currently own, along with shares of Morgan Stanley
Dean Witter Funds you currently own that you acquired in
exchange for those shares.
NO SALES CHARGES FOR REINVESTED CASH DISTRIBUTIONS If you
receive a cash payment representing an income dividend or
capital gain and you reinvest that amount in the applicable
Class of shares by returning the check within 30 days of the
payment date, the purchased shares would not be subject to
an initial sales charge or CDSC.
PLAN OF DISTRIBUTION (RULE 12B-1 FEES) The Fund has
adopted a Plan of Distribution in accordance with Rule 12b-1
under the Investment Company Act of 1940 with respect to the
distribution of Class A, Class B and Class C shares. The
Plan allows the Fund to pay distribution fees for the sale
and distribution of these shares. It also allows the Fund to
pay for services to shareholders of Class A, Class B and
Class C shares. Because these fees are paid out of the
Fund's assets on an ongoing basis, over time these fees will
increase the cost of your investment in these Classes and
may cost you more than paying other types of sales charges.
20
<PAGE>
FINANCIAL HIGHLIGHTS
The financial highlights table is intended to help you understand the
Fund's financial performance for the past 5 fiscal years of the Fund.
Certain information reflects financial results for a single Fund share.
The total returns in the table represent the rate an investor would have
earned or lost on an investment in the Fund (assuming reinvestment of
all dividends and distributions).
This information has been audited by PricewaterhouseCoopers LLP,
independent accountants, whose report, along with the Fund's financial
statements, is included in the annual report, which is available upon
request.
<TABLE>
<CAPTION>
CLASS B SHARES
- ----------------------------------------------------------------------------------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31 1998 1997* 1996 1995 1994
<S> <C> <C> <C> <C> <C>
- ----------------------------------------------------------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
- ----------------------------------------------------------------------------------------------------------------------------
Net asset value, beginning of period $ 12.92 $ 12.57 $ 12.92 $ 11.87 $ 13.31
- ----------------------------------------------------------------------------------------------------------------------------
Net investment income 0.58 0.57 0.58 0.61 0.64
Net realized and unrealized gain (loss) 0.13 0.35 (0.21) 1.13 (1.42)
------- ------- -------- -------- -----------
Total from investment operations 0.71 0.92 0.37 1.74 (0.78)
- ----------------------------------------------------------------------------------------------------------------------------
LESS DIVIDENDS AND DISTRIBUTIONS FROM:
Net investment income (0.58) (0.57) (0.58) (0.61) (0.64)
Paid-in-capital (0.24) -- (0.14) (0.08) (0.02)
------- ------- -------- -------- -----------
Total dividends and distributions (0.82) (0.57) (0.72) (0.69) (0.66)
- ----------------------------------------------------------------------------------------------------------------------------
Net asset value, end of period $ 12.81 $ 12.92 $ 12.57 $ 12.92 $ 11.87
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN+ 5.63% 7.51% 3.13% 14.96% (5.97)%
- ----------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
- ----------------------------------------------------------------------------------------------------------------------------
Expenses 0.95%(2)(3) 1.33% 1.32%(1) 1.33% 1.32%
- ----------------------------------------------------------------------------------------------------------------------------
Net investment income 4.46%(2)(3) 4.51% 4.66% 4.90% 5.10%
- ----------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
- ----------------------------------------------------------------------------------------------------------------------------
Net assets, end of period, in thousands $ 897 $ 914 $ 976 $ 1,055 $ 1,008
- ----------------------------------------------------------------------------------------------------------------------------
Portfolio turnover rate 20% 15% 11% 23% 12%
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
* Prior to July 28, 1997, the Fund issued one class of shares. All shares of the
Fund held prior to that date have been designated as Class B shares.
+ Does not reflect the deduction of sales charge. Calculated based on the net
asset value as of the last business day of the period.
(1) Does not reflect the effect of expenses offset of 0.01%.
(2)Reflects overall Fund ratios for investment income and non-class specific
expenses.
(3)If the Distributor had not rebated a portion of its fees to Fund, the
expenses and net investment income ratios would have been 1.33% and 4.08%,
respectively.
21
<PAGE>
<TABLE>
<CAPTION>
CLASS A SHARES
- --------------------------------------------------------------------------------------------------
FOR THE YEAR ENDED FOR THE PERIOD JULY 28, 1997*
DECEMBER 31, 1998 THROUGH DECEMBER 31, 1997
<S> <C> <C>
- --------------------------------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
- --------------------------------------------------------------------------------------------------
Net asset value, beginning of period $12.89 $12.80
- --------------------------------------------------------------------------------------------------
Net investment income 0.59 0.27
Net realized and unrealized gain 0.10 0.09
------ ------
Total from investment operations 0.69 0.36
- --------------------------------------------------------------------------------------------------
Less dividends from:
Net investment income (0.59) (0.27)
Net realized gain (0.24) --
------ ------
Total dividends and distributions (0.83) (0.27)
- --------------------------------------------------------------------------------------------------
Net asset value, end of period $12.75 $12.89
- --------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN+ 5.50% 2.82%(1)
- --------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
- --------------------------------------------------------------------------------------------------
Expenses 0.83%(3) 0.78%(2)
- --------------------------------------------------------------------------------------------------
Net investment income 4.58%(3) 4.47%(2)
- --------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
- --------------------------------------------------------------------------------------------------
Net assets, end of period, in
thousands $3,788 $1,175
- --------------------------------------------------------------------------------------------------
Portfolio turnover rate 20% 15%
- --------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
CLASS C SHARES
<S> <C> <C>
- --------------------------------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:(1)
- --------------------------------------------------------------------------------------------------
Net asset value, beginning of period $12.92 $12.80
- --------------------------------------------------------------------------------------------------
Net investment income 0.53 0.23
Net realized and unrealized gain 0.13 0.12
------ ------
Total from investment operations 0.66 0.35
- --------------------------------------------------------------------------------------------------
Less dividends from:
Net investment income (0.53) (0.23)
Net realized gain (0.24) --
------ ------
Total dividends and distributions (0.77) (0.23)
- --------------------------------------------------------------------------------------------------
Net asset value, end of period $12.81 $12.92
- --------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN+ 5.22% 2.80%(1)
- --------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
- --------------------------------------------------------------------------------------------------
Expenses 1.33%(3) 1.31%(2)
- --------------------------------------------------------------------------------------------------
Net investment income 4.08%(3) 4.24%(2)
- --------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
- --------------------------------------------------------------------------------------------------
Net assets, end of period, in
thousands $9,849 $3,610
- --------------------------------------------------------------------------------------------------
Portfolio turnover rate 20% 15%
- --------------------------------------------------------------------------------------------------
</TABLE>
* The date shares were first issued.
+ Does not reflect the deduction of sales charge. Calculated based on the net
asset value as of the last business day of the period.
(1) Not annualized.
(2) Annualized.
(3) Reflects overall Fund ratios for investment income and non-class specific
expenses.
22
<PAGE>
<TABLE>
<CAPTION>
CLASS D SHARES
- --------------------------------------------------------------------------------------------------
FOR THE YEAR ENDED FOR THE PERIOD JULY 28, 1997*
DECEMBER 31, 1998 THROUGH DECEMBER 31, 1997
<S> <C> <C>
- --------------------------------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
- --------------------------------------------------------------------------------------------------
Net asset value, beginning of period $12.92 $12.80
- --------------------------------------------------------------------------------------------------
Net investment income 0.63 0.28
Net realized and unrealized gain 0.10 0.12
------ ------
Total from investment operations 0.73 0.40
- --------------------------------------------------------------------------------------------------
Less dividends from:
Net investment income (0.63) (0.28)
Net realized gain (0.24) --
------ ------
Total dividends and distributions (0.87) (0.28)
- --------------------------------------------------------------------------------------------------
Net asset value, end of period $12.78 $12.92
- --------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN+ 5.77% 3.18%(1)
- --------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
- --------------------------------------------------------------------------------------------------
Expenses 0.58%(3) 0.60%(2)
- --------------------------------------------------------------------------------------------------
Net investment income 4.83%(3) 5.34%(2)
- --------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
- --------------------------------------------------------------------------------------------------
Net assets, end of period, in
thousands $ 554 $ 45
- --------------------------------------------------------------------------------------------------
Portfolio turnover rate 20% 15%
- --------------------------------------------------------------------------------------------------
</TABLE>
* The date shares were first issued.
+ Calculated based on the net asset value as of the last business day of the
period.
(1) Not annualized.
(2) Annualized.
(3) Reflects overall Fund ratios for investment income and non-class specific
expenses.
23
<PAGE>
MORGAN STANLEY DEAN WITTER
FAMILY OF FUNDS
The Morgan Stanley Dean Witter Family of Funds
offers investors a wide range of investment
choices. Come on in and meet the family!
- --------------------------------------------------------------------------------
GROWTH FUNDS
- --------------------------------
GROWTH FUNDS
Aggressive Equity Fund
American Opportunities Fund
Capital Growth Securities
Developing Growth Securities
Equity Fund
Growth Fund
Market Leader Trust
Mid-Cap Growth Fund
Special Value Fund
Value Fund
THEME FUNDS
Financial Services Trust
Health Sciences Trust
Information Fund
Natural Resource Development Securities
Precious Metals and Minerals Trust
GLOBAL/INTERNATIONAL FUNDS
Competitive Edge Fund - "Best Ideas" Portfolio
European Growth Fund
Fund of Funds - International Portfolio
Global Dividend Growth Securities
International SmallCap Fund
Japan Fund
Pacific Growth Fund
- --------------------------------------------------------------------------------
GROWTH & INCOME FUNDS
- --------------------------------
Balanced Growth Fund
Balanced Income Fund
Convertible Securities Trust
Dividend Growth Securities
Fund of Funds - Domestic Portfolio
Income Builder Fund
Mid-Cap Dividend Growth Securities
S&P 500 Index Fund
S&P 500 Select Fund
Strategist Fund
Value-Added Market Series/Equity Portfolio
THEME FUNDS
Global Utilities Fund
Real Estate Fund
Utilities Fund
- --------------------------------------------------------------------------------
INCOME FUNDS
- --------------------------------
GOVERNMENT INCOME FUNDS
Federal Securities Trust
Short-Term U.S. Treasury Trust
U.S. Government Securities Trust
DIVERSIFIED INCOME FUNDS
Diversified Income Trust
CORPORATE INCOME FUNDS
High Yield Securities
Intermediate Income Securities
Short-Term Bond Fund (NL)
GLOBAL INCOME FUNDS
World Wide Income Trust
TAX-FREE INCOME FUNDS
California Tax-Free Income Fund
Hawaii Municipal Trust (FSC)
Limited Term Municipal Trust (NL)
Multi-State Municipal Series Trust (FSC)
New York Tax-Free Income Fund
Tax-Exempt Securities Trust
- --------------------------------------------------------------------------------
MONEY MARKET FUNDS
- --------------------------------
TAXABLE MONEY MARKET FUNDS
Liquid Asset Fund (MM)
U.S. Government Money Market Trust (MM)
TAX-FREE MONEY MARKET FUNDS
California Tax-Free Daily Income Trust (MM)
N.Y. Municipal Money Market Trust (MM)
Tax-Free Daily Income Trust (MM)
There may be Funds created after this PROSPECTUS was published. Please consult
the inside front cover of a new Fund's prospectus for its designation, e.g.,
Multi-Class Fund or Money Market Fund.
Unless otherwise noted, each listed Morgan Stanley Dean Witter Fund, except for
Short-Term U.S. Treasury Trust, is a Multi-Class Fund. A mutual fund offering
multiple Classes of shares. The other types of funds are: NL - No-Load (Mutual)
Fund; MM - Money Market Fund; FSC - A mutual fund sold with a front-end sales
charge and a distribution (12b-1) fee.
<PAGE>
MORGAN STANLEY DEAN WITTER
CALIFORNIA TAX-FREE INCOME FUND
(Sidebar)
TICKER SYMBOLS:
CLASS A: CLFAX
- -------------------
CLASS B: CLFBX
- -------------------
CLASS C: CLFCX
- -------------------
CLASS D: CLFDX
- -------------------
(End Sidebar)
Additional information about the Fund's investments is
available in the Fund's ANNUAL AND SEMI-ANNUAL REPORTS TO
SHAREHOLDERS. In the Fund's ANNUAL REPORT, you will find a
discussion of the market conditions and investment
strategies that significantly affected the Fund's
performance during its last fiscal year. The Fund's
Statement of Additional Information also provides additional
information about the Fund. The Statement of Additional
Information is incorporated herein by reference (legally is
part of this PROSPECTUS). For a free copy of any of these
documents, to request other information about the Fund, or
to make shareholder inquiries, please call:
(800) 869-NEWS
You also may obtain information about the Fund by calling
your Morgan Stanley Dean Witter Financial Advisor or by
visiting our Internet site at:
www.deanwitter.com/funds
Information about the Fund (including the STATEMENT OF
ADDITIONAL INFORMATION) can be viewed and copied at the
Securities and Exchange Commission's Public Reference Room
in Washington, DC. Information about the Reference Room's
operations may be obtained by calling the SEC at (800)
SEC-0330. Reports and other information about the Fund are
available on the SEC's Internet site (www.sec.gov), and
copies of this information may be obtained, upon payment of
a duplicating fee, by writing the Public Reference Section
of the SEC, Washington, DC 20549-6009.
INVESTMENT COMPANY ACT FILE NO. 811-4020)
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION MORGAN
MAY 1, 1999 STANLEY
DEAN WITTER
CALIFORNIA
TAX-FREE
INCOME FUND
- --------------------------------------------------------------------------------
This STATEMENT OF ADDITIONAL INFORMATION is not a PROSPECTUS. The PROSPECTUS
(dated May 1, 1999) for the Morgan Stanley Dean Witter California Tax-Free
Income Fund may be obtained without charge from the Fund at its address or
telephone number listed below or from Dean Witter Reynolds at any of its branch
offices.
Morgan Stanley Dean Witter
California Tax-Free Income Fund
Two World Trade Center
New York, New York 10048
(800) 869-NEWS
<PAGE>
TABLE OF CONTENTS
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
I. Fund History........................................................................ 4
II. Description of the Fund and Its Investments and Risks.............................. 4
A. Classification.................................................................... 4
B. Investment Strategies and Risks................................................... 4
C. Fund Policies/Investment Restrictions............................................. 13
III. Management of the Fund............................................................ 14
A. Board of Trustees................................................................. 14
B. Management Information............................................................ 15
C. Compensation...................................................................... 19
IV. Control Persons and Principal Holders of Securities................................ 21
V. Investment Management and Other Services............................................ 22
A. Investment Manager................................................................ 22
B. Principal Underwriter............................................................. 22
C. Services Provided by the Investment Manager and Fund Expenses Paid by Third
Parties............................................................................. 23
D. Dealer Reallowances............................................................... 24
E. Rule 12b-1 Plan................................................................... 24
F. Other Service Providers........................................................... 27
VI. Brokerage Allocation and Other Practices........................................... 28
A. Brokerage Transactions............................................................ 28
B. Commissions....................................................................... 28
C. Brokerage Selection............................................................... 28
D. Directed Brokerage................................................................ 29
E. Regular Broker-Dealers............................................................ 29
VII. Capital Stock and Other Securities................................................ 29
VIII. Purchase, Redemption and Pricing of Shares....................................... 30
A. Purchase of Shares................................................................ 30
B. Offering Price.................................................................... 30
IX. Taxation of the Fund and Shareholders.............................................. 31
X. Underwriters........................................................................ 34
XI. Calculation of Performance Data.................................................... 34
XII. Financial Statements.............................................................. 35
XIII. Appendix -- rating of investments................................................ 54
</TABLE>
2
<PAGE>
GLOSSARY OF SELECTED DEFINED TERMS
- --------------------------------------------------------------------------------
The terms defined in this glossary are frequently used in this STATEMENT OF
ADDITIONAL INFORMATION (other terms used occasionally are defined in the text of
the document).
"CUSTODIAN"--The Bank of New York.
"DEAN WITTER REYNOLDS"--Dean Witter Reynolds Inc., a wholly-owned broker-dealer
subsidiary of MSDW.
"DISTRIBUTOR"--Morgan Stanley Dean Witter Distributors Inc., a wholly-owned
broker-dealer subsidiary of MSDW.
"FINANCIAL ADVISORS"--Morgan Stanley Dean Witter authorized financial services
representatives.
"FUND"--Morgan Stanley Dean Witter California Tax-Free Income Fund, a registered
open-end investment company.
"INVESTMENT MANAGER"--Morgan Stanley Dean Witter Advisors Inc., a wholly-owned
investment advisor subsidiary of MSDW.
"INDEPENDENT TRUSTEES"--Trustees who are not "interested persons" (as defined by
the Investment Company Act) of the Fund.
"MORGAN STANLEY & CO."--Morgan Stanley & Co. Incorporated, a wholly-owned
broker-dealer subsidiary of MSDW.
"MORGAN STANLEY DEAN WITTER FUNDS"--Registered investment companies (i) for
which the Investment Manager serves as the investment advisor; and (ii) that
hold themselves out to investors as related companies for investment and
investor services.
"MSDW"--Morgan Stanley Dean Witter & Co., a preeminent global financial services
firm.
"MSDW SERVICES COMPANY"--Morgan Stanley Dean Witter Services Company Inc., a
wholly-owned fund services subsidiary of the Investment Manager.
"TRANSFER AGENT"--Morgan Stanley Dean Witter Trust FSB, a wholly-owned transfer
agent subsidiary of MSDW.
"TRUSTEES"--The Board of Trustees of the Fund.
3
<PAGE>
I. FUND HISTORY
- --------------------------------------------------------------------------------
The Fund was organized under the laws of the Commonwealth of Massachusetts
on April 9, 1984 as a Massachusetts business trust under the name Dean Witter
California Tax-Free Income Fund. Effective June 22, 1998, the Fund's name was
changed to Morgan Stanley Dean Witter California Tax-Free Income Fund.
II. DESCRIPTION OF THE FUND AND ITS INVESTMENTS AND RISKS
- --------------------------------------------------------------------------------
A. CLASSIFICATION
The Fund is an open-end, diversified management investment company whose
investment objective is to provide a high level of current income exempt from
both federal and California income tax, consistent with the preservation of
capital.
B. INVESTMENT STRATEGIES AND RISKS
The following discussion of the Fund's investment strategies and risks
should be read with the sections of the Fund's PROSPECTUS titled "Principal
Investment Strategies," "Principal Risks," "Additional Investment Strategy
Information" and "Additional Risk Information."
TAXABLE SECURITIES. The Fund may invest up to 20% of its total assets, or
more than 20% of its total assets when assuming a temporary defensive position,
in taxable money market instruments, tax-exempt securities of other states and
municipalities and futures and options. Investments in taxable money market
instruments would generally be made under any one of the following
circumstances: (a) pending investment of proceeds of the sale of the Fund's
shares or of portfolio securities, (b) pending settlement of purchases of
portfolio securities and (c) to maintain liquidity for the purpose of meeting
anticipated redemptions. Only those tax-exempt securities of other states which
satisfy the standards established for the tax-exempt securities of the state of
California may be purchased by the Fund.
The types of taxable money market instruments in which the Fund may invest
are limited to the following short-term fixed-income securities (maturing in one
year or less from the time of purchase): (i) obligations of the United States
Government, its agencies, instrumentalities or authorities; (ii) commercial
paper rated P-1 by Moody's Investors Services, Inc. ("Moody's") or A-1 by
Standard & Poor's Corporation ("S&P"); (iii) certificates of deposit of domestic
banks with assets of $1 billion or more; and (iv) repurchase agreements with
respect to portfolio securities.
VARIABLE RATE AND FLOATING RATE OBLIGATIONS. The Fund may invest in
Municipal Bonds and Municipal Notes ("Municipal Obligations") of the type called
variable rate. The interest rate payable on a variable rate obligation is
adjusted either at predesignated periodic intervals or whenever there is a
change in the market rate of interest on which the interest rate payable is
based. Other features may include the right whereby the Fund may demand
prepayment of the principal amount of the obligation prior to its stated
maturity (a "demand feature") and the right of the issue to prepay the principal
amount prior to maturity. The principal benefit of a variable rate obligation is
that the interest rate adjustment minimizes changes in the market value of the
obligation. The principal benefit to the Fund of purchasing obligations with a
demand feature is that liquidity, and the ability of the Fund to obtain
repayment of the full principal amount of an obligation prior to maturity, is
enhanced.
FUTURES CONTRACTS AND OPTIONS ON FUTURES. The Fund may invest in financial
futures contracts ("futures contracts") and related options thereon. These
futures contracts and related options thereon will be used only as a hedge
against anticipated interest rate changes. A futures contract sale creates an
obligation by the Fund, as seller, to deliver the specific type of instrument
called for in the contract at a specified future time for a specified price. A
futures contract purchase would create an obligation by the Fund, as purchaser,
to take delivery of the specific type of financial instrument at a specified
future time at a specified price. The specific securities delivered or taken,
respectively, at settlement date, would not be determined until on or near that
date. The determination would be in accordance with the rules of the exchange on
which the futures contract sale or purchase was effected.
4
<PAGE>
Although the terms of futures contracts specify actual delivery or receipt
of securities, in most instances the contracts are closed out before the
settlement date without the making or taking of delivery of the securities.
Closing out of a futures contract is usually effected by entering into an
offsetting transaction. An offsetting transaction for a futures contract sale is
effected by the Fund entering into a futures contract purchase for the same
aggregate amount of the specific type of financial instrument at the same
delivery date. If the price in the sale exceeds the price in the offsetting
purchase, the Fund is immediately paid the difference and thus realizes a gain.
If the offsetting purchase price exceeds the sale price, the Fund pays the
difference and realizes a loss. Similarly, the closing out of a futures contract
purchase is effected by the Fund entering into a futures contract sale. If the
offsetting sale price exceeds the purchase price, the Fund realizes a gain, and
if the offsetting sale price is less than the purchase price, the Fund realizes
a loss.
Unlike a futures contract, which requires the parties to buy and sell a
security on a set date, an option on a futures contract entitles its holder to
decide on or before a future date whether to enter into such a contract (a long
position in the case of a call option and a short position in the case of a put
option). If the holder decides not to enter into the contract, the premium paid
for the contract is lost. Since the value of the option is fixed as the point of
sale, there are no daily payments of cash to reflect the change in the value of
the underlying contract, as discussed below for futures contracts. The value of
the option change is reflected in the net asset value of the Fund.
The Fund is required to maintain margin deposits with brokerage firms
through which it effects futures contracts and options thereon. The initial
margin requirements vary according to the type of the underlying security. In
addition, due to current industry practice, daily variations in gains and losses
on open contracts are required to be reflected in cash in the form of variation
margin payments. The Fund may be required to make additional margin payments
during the term of the contract.
Currently, futures contracts can be purchased on debt securities such as
U.S. Treasury Bills and Bonds, U.S. Treasury Notes with maturities between 6 1/2
and 10 years, Certificates of the Government National Mortgage Association, Bank
Certificates of Deposit and on a municipal bond index. The Fund may invest in
interest rate futures contracts covering these types of financial instruments as
well as in new types of contracts that become available in the future.
Financial futures contracts are traded in an auction environment on the
floors of several Exchanges--principally, the Chicago Board of Trade, the
Chicago Mercantile Exchange and the New York Futures Exchange. Each Exchange
guarantees performance under contract provisions through a clearing corporation,
a nonprofit organization managed by the Exchange membership which is also
responsible for handling daily accounting of deposits or withdrawals of margin.
A risk in employing futures contracts may correlate imperfectly with the
behavior of the cash prices of the Fund's portfolio securities. The correlation
may be distorted by the fact that the futures market is dominated by short-term
traders seeking to profit from the difference between a contract or security
price objective and a short time period. The correlation may be further
distorted since the futures contracts that are being used to hedge are not based
on municipal obligations.
Another risk is that the Fund's Investment Manager could be incorrect in its
expectations as to the direction or extent of various interest rate movements or
the time span within which the movements take place. For example, if the Fund
sold futures contracts for the sale of securities in anticipation of an increase
in interest rates, and the interest rates went down instead, causing bond prices
to rise, the Fund would lose money on the sale. Put and call options on
financial futures have characteristics similar to Exchange traded options.
In addition to the risks associated in investing in options on securities,
there are particular risks associated with investing in options on futures. In
particular, the ability to establish and close out positions on such options
will be subject to the development and maintenance of a liquid secondary market.
It is not certain that such a market will develop.
5
<PAGE>
The Fund may not enter into futures contracts or related options thereon if,
immediately thereafter, the amount committed to margin plus the amount paid for
option premiums exceeds 5% of the value of the Fund's total assets. There is no
limit, however, on the percentage of the Fund's assets that may be committed to
hedging transactions.
MUNICIPAL BOND INDEX FUTURES. The Fund may utilize municipal bond index
futures contracts for hedging purposes. The strategies in employing such
contracts will be similar to that discussed above with respect to financial
futures and options thereon. A municipal bond index is a method of reflecting in
a single number the market value of many different municipal bonds and is
designed to be representative of the municipal bond market generally. The index
fluctuates in response to changes in the market values of the bonds included
within the index. Unlike futures contracts on particular financial instruments,
transactions in futures on a municipal bond index will be settled in cash, if
held until the close of trading in the contract. However, like any other futures
contract, a position in the contract may be closed out by a purchase or sale of
an offsetting contract for the same delivery month prior to expiration of the
contract.
OPTIONS.
The Fund may purchase or sell (write) options on debt securities as a means
of achieving additional return or hedging the value of the Fund's portfolio. The
Fund will only buy options listed on national securities exchanges. The Fund
will not purchase options if, as a result, the aggregate cost of all outstanding
options exceeds 10% of the Fund's total assets.
Presently there are no options on California tax-exempt securities traded on
national securities exchanges. The Fund will not invest in options on debt
securities in the coming year or until such time as they become available on
national securities exchanges.
A call option is a contract that gives the holder of the option the right to
buy from the writer of the call option, in return for a premium, the security
underlying the option at a specified exercise price at any time during the term
of the option. The writer of the call option has the obligation, upon exercise
of the option, to deliver the underlying security upon payment of the exercise
price during the option period. A put option is a contract that gives the holder
of the option the right to sell to the writer, in return for a premium, the
underlying security at a specified price during the term of the option. The
writer of the put has the obligation to buy the underlying security upon
exercise, at the exercise price during the option period.
The Fund will only write covered call or covered put options listed on
national exchanges. The Fund may not write covered options in an amount
exceeding 20% of the value of the total assets of the Fund. A call option is
"covered" if the Fund owns the underlying security covered by the call or has an
absolute and immediate right to acquire that security or futures contract
without additional cash consideration (or for additional cash consideration held
in a segregated account by its custodian) upon conversion or exchange of other
securities held in its portfolio. A call option is also covered if the Fund
holds a call on the same security or futures contract as the call written, where
the exercise price of the call held is (i) equal to or less than the exercise
price of the call written or (ii) greater than the exercise price of the call
written if the difference is maintained by the Fund in cash, Treasury bills or
other liquid portfolio securities in a segregated account with its custodian. A
put option is "covered" if the Fund maintains cash, Treasury bills or other
liquid portfolio securities with a value equal to the exercise price in a
segregated account with its custodian, or else holds a put on the same security
or futures contract as the put written where the exercise price of the put held
is equal to or greater than the exercise price of the put written.
If the Fund has written an option, it may terminate its obligation by
effecting a closing purchase transaction. This is accomplished by purchasing an
option of the same series as the option previously written. However, once the
Fund has been assigned an exercise notice, the Fund will be unable to effect a
closing purchase transaction. Similarly, if the Fund is the holder of an option,
it may liquidate its position by effecting a closing sale transaction. This is
accomplished by selling an option of the same fund as the option previously
purchased. There can be no assurance that either a closing purchase or sale
transaction on behalf of the Fund can be effected when the Fund so desires.
6
<PAGE>
The Fund will realize a profit from a closing transaction if the price of
the transaction is less than the premium received from writing the option or is
more than the premium paid to purchase the option; the Fund will realize a loss
from a closing transaction if the price of the transaction is more than the
premium received from writing the option or is less than the premium paid to
purchase the option. Since call option prices generally reflect increases in the
price of the underlying security, any loss resulting from the purchase of a call
option may also be wholly or partially offset by unrealized appreciation of the
underlying security. If a put option written by the Fund is exercised, the Fund
may incur a loss equal to the difference between the exercise price of the
option and the sum of the sale price of the underlying security plus the
premiums received from the sale of the option. Other principal factors affecting
the market value of a put or a call option include supply and demand, interest
rates, the current market price and price volatility of the underlying security
and the time remaining until the expiration date.
An option position may be closed out only on an exchange which provides a
secondary market for an option of the same series. Although the Fund will
generally purchase or write only those options for which there appears to be an
active secondary market, there is no assurance that a liquid secondary market on
an exchange will exist for any particular option. In such event, it might not be
possible to effect closing transactions in particular options, so that the Fund
would have to exercise its options in order to realize any profit and would
incur brokerage commission upon the exercise of call options and upon covered
call option writer is unable to effect a closing purchase transaction in a
secondary market, it will not be able to sell the underlying security until the
option expires or it delivers the underlying security upon exercise.
REPURCHASE AGREEMENTS. The Fund may invest in repurchase agreements. When
cash may be available for only a few days, it may be invested by the Fund in
repurchase agreements until such time as it may otherwise be invested or used
for payments of obligations of the Fund. These agreements, which may be viewed
as a type of secured lending by the Fund, typically involve the acquisition by
the Fund of debt securities from a selling financial institution such as a bank,
savings and loan association or broker-dealer. The agreement provides that the
Fund will sell back to the institution, and that the institution will
repurchase, the underlying security serving as collateral at a specified price
and at a fixed time in the future, usually not more than seven days from the
date of purchase. The collateral will be marked-to-market daily to determine
that the value of the collateral, as specified in the agreement, does not
decrease below the purchase price plus accrued interest. If such decrease
occurs, additional collateral will be requested and, when received, added to the
account to maintain full collateralization. The Fund will accrue interest form
the institution until the time when the repurchase is to occur. Although this
date is deemed by the Fund to be the maturity date of a repurchase agreement,
the maturities of securities subject to repurchase agreements are not subject to
any limits.
While repurchase agreements involve certain risks not associated with direct
investments in debt securities, the Fund follows procedures designed to minimize
such risks. These procedures include effecting repurchase transactions only with
large, well-capitalized and well-established financial institutions whose
financial condition will be continually monitored by the Investment Manager
subject to procedures established by the Trustees. In addition, as described
above, the value of the collateral underlying the repurchase agreement will be
at least equal to the repurchase price, including any accrued interest earned on
the repurchase agreement. In the event of a default or bankruptcy by a selling
financial institution, the Fund will seek to liquidate such collateral. However,
the exercising of the Fund's right to liquidate such collateral could involve
certain costs or delays and, to the extent that proceeds form any sale upon a
default of the obligation to repurchase were less than the repurchase price, the
Fund could suffer a loss.
LENDING PORTFOLIO SECURITIES. The Fund may lend its portfolio securities to
brokers, dealers and other financial institutions, provided that the loans are
callable at any time by the Fund, and are at all
7
<PAGE>
times secured by cash or cash equivalents, which are maintained in a segregated
account pursuant to applicable regulations and that are equal to at least 100%
of the market value, determined daily, of the loaned securities. The advantage
of these loans is that the Fund continues to receive the income on the loaned
securities while at the same time earning interest on the cash amounts deposited
as collateral, which will be invested in short-term obligations. The Fund will
not lend its portfolio securities if such loans are not permitted by the laws or
regulations of any state in which its shares are qualified for sale and will not
lend more than 25% of the value of its total assets.
As with any extensions of credit, there are risks of delay in recovery and,
in some cases, even loss of rights in the collateral should the borrower of the
securities fail financially. However, these loans of portfolio securities will
only be made to firms deemed by the Fund's management to be creditworthy and
when the income which can be earned from such loans justifies the attendant
risks. Upon termination of the loan, the borrower is required to return the
securities to the Fund. Any gain or loss in the market price during the loan
period would inure to the Fund.
When voting or consent rights which accompany loaned securities pass to the
borrower, the Fund will follow the policy of calling the loaned securities, to
be delivered within one day after notice, to permit the exercise of the rights
if the matters involved would have a material effect on the Fund's investment in
the loaned securities. The Fund will pay reasonable finder's, administrative and
custodial fees in connection with a loan of its securities.
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES AND FORWARD COMMITMENTS. From
time to time the Fund may purchase securities on a when-issued or delayed
delivery basis or may purchase or sell securities on a forward commitment basis.
When these transactions are negotiated, the price is fixed at the time of the
commitment, but delivery and payment can take place a month or more after the
date of commitment. While the Fund will only purchase securities on a
when-issued, delayed delivery or forward commitment basis with the intention of
acquiring the securities, the Fund may sell the securities before the settlement
date, if it is deemed advisable. The securities so purchased or sold are subject
to market fluctuation and no interest or dividends accrue to the purchaser prior
to the settlement date.
At the time the Fund makes the commitment to purchase or sell securities on
a when-issued, delayed delivery or forward commitment basis, it will record the
transaction and thereafter reflect the value, each day, of such security
purchased, or if a sale, the proceeds to be received, in determining its net
asset value. At the time of delivery of the securities, their value may be more
or less than the purchase or sale price. An increase in the percentage of the
Fund's assets committed to the purchase of securities on a when-issued, delayed
delivery or forward commitment basis may increase the volatility of its net
asset value. The Fund will also establish a segregated account on the Fund's
books in which it will continually maintain cash or cash equivalents or other
liquid portfolio securities equal in value to commitments to purchase securities
on a when-issued, delayed delivery or forward commitment basis.
8
<PAGE>
YEAR 2000. The investment management services provided to the Fund by the
Investment Manager and the services provided to shareholders by the Distributor
and the Transfer Agent 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 some other date, 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 Investment
Manager, the Distributor and the Transfer Agent have been actively working on
necessary changes to their own computer systems to prepare for the year 2000 and
expect that their systems will be adapted before that date, but there can be no
assurance that they will be successful, or that interaction with other
non-complying computer systems will not impair their services at that time.
In addition, it is possible that the markets for securities in which the
Fund invests may be detrimentally affected by computer failures throughout the
financial services industry beginning January 1, 2000. Improperly functioning
trading 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 Fund's investments may be adversely affected.
THE STATE OF CALIFORNIA--SPECIAL INVESTMENT CONSIDERATIONS
The following describes certain risks with respect to municipal obligations
of California issuers in which the Fund may invest. This summarized information
is based on information drawn from official statements and prospectuses relating
to securities offerings of the State of California and other public documents
available as of the date of this Statement of Additional Information. Although
the Investment Manager has not independently verified such information, it has
no reason to believe that such information is not correct in all material
respects.
The Fund will be affected by any political, economic or regulatory
developments affecting the ability of California issuers to pay interest or
repay principal. Provisions of the California Constitution and State statutes
which limit the taxing and spending authority of California governmental
entities may impair the ability of California issuers to maintain debt service
on their obligations. Future California political and economic developments,
constitutional amendments, legislative measures, executive orders,
administrative regulations, litigation and voter initiatives could have an
adverse effect on the debt obligations of California issuers.
Certain debt obligations held by the Fund may be obligations of issuers
which rely in whole or in substantial part on California state revenues for the
continuance of their operations and payment of their obligations. Whether and to
what extent the California Legislature will continue to appropriate a portion of
the State's General Fund to counties, cities and their various entities, is not
entirely certain. To the extent local entities do not receive money from the
State to pay for their operations and services, their ability to pay debt
service on obligations held by the Fund may be impaired.
In 1978, Proposition 13, an amendment to the California Constitution, was
approved, limiting real property valuation for property tax purposes and the
power of local governments to increase real property tax revenues and revenues
from other sources. Legislation adopted after Proposition 13 provided for
assistance to local governments, including the redistribution of the
then-existing surplus in the General Fund, reallocation of revenues to local
governments, and assumption by the State of certain local government
obligations. However, more recent legislation reduced such state assistance.
There can be no assurance that any particular level of State aid to local
governments will be maintained in future years. In NORDLINGER V. HAHN, the
United States Supreme Court upheld certain provisions of Proposition 13 against
claims that it violated the equal protection clause of the Constitution.
In 1979, an amendment was passed adding Article XIIIB to the State
Constitution. As amended in 1990, Article XIIIB imposes an "appropriations
limit" on the spending authority of the State and local government entities. In
general, the appropriations limit is based on certain 1978-1979 expenditures,
adjusted annually to reflect changes in the cost of living, population and
certain services provided by
9
<PAGE>
State and local government entities. "Appropriations limit" does not include
appropriations for qualified capital outlay projects, certain increases in
transportation-related taxes, and certain emergency appropriations.
If a government entity raises revenues beyond its "appropriations limit" in
any year, a portion of the excess which cannot be appropriated within the
following year's limit must be returned to the entity's taxpayers within two
subsequent fiscal years, generally by a tax credit, refund or temporary
suspension of tax rates or fee schedules. "Debt service" is excluded from these
limitations, and is defined as "appropriations required to pay the cost of
interest and redemption charges, including the funding of any reserve or sinking
fund required in connection therewith, on indebtedness existing or legally
authorized as of January 1, 1979 or on bonded indebtedness thereafter approved
[by the voters]." In addition, Article XIIIB requires the State Legislature to
establish a prudent State reserve, and to require the transfer of 50% of excess
revenue to the State School Fund; any amounts allocated to the State School Fund
will increase the appropriations limit.
In June 1982, the voters of California passed two initiative measures to
repeal the California gift and inheritance tax laws and to enact, in lieu
thereof, California death taxes. California voters also passed an initiative
measure to increase, for taxable years commencing on or after January 1, 1982,
the amount to account for the effects of inflation. Decreases in State and local
revenues in future fiscal years as a consequence of these initiatives may result
in reductions in allocations of state revenues to California issuers or in the
ability of California issuers to pay their obligations.
In 1986, California voters approved an initiative statute known as
Proposition 62. This initiative (i) requires that any tax for general
governmental purposes imposed by local governments be approved by resolution or
ordinance adopted by a two-thirds vote of the governmental entity's legislative
body and by a majority vote of the electorate of the governmental entity, (ii)
requires that any special tax (defined as tax levied for other than general
governmental purposes) imposed by a local governmental entity be approved by a
two-thirds vote of the voters within that jurisdiction, (iii) restricts the use
of revenues from a special tax to the purposes or for the service for which the
special tax was imposed, (iv) prohibits the imposition of ad valorem taxes on
real property by local governmental entities except as permitted by the
Proposition 13 amendment, (v) prohibits the imposition of transaction taxes and
sales taxes on the sale of real property by local governments, (vi) requires
that any tax imposed by a local government on or after August 1, 1985, be
ratified by a majority vote of the electorate within two years of the adoption
of the initiative or be terminated by November 15, 1989, (vii) requires that, in
the event a local government fails to comply with the provisions of this
measure, a reduction of the amount of property tax revenue allocated to such
local government occurs in an amount equal to the revenues received by such
entity attributable to the tax levied in violation of the initiative, and (viii)
permits these provisions to be amended exclusively by the voters of the State of
California.
In September 1995, the California Supreme Court upheld the constitutionality
of Proposition 62, creating uncertainty as to the legality of certain local
taxes enacted by non-charter cities in California without voter approval. It is
not possible to predict the impact of the decision.
In November 1996, California voters approved Proposition 218. The initiative
applied the provisions of Proposition 62 to all entities, including charter
cities. It requires that all taxes for general purposes obtain a simple majority
popular vote and that taxes for special purposes obtain a two-thirds majority
vote. Prior to the effectiveness of Proposition 218, charter cities could levy
certain taxes such as transient occupancy taxes and utility user's taxes without
a popular vote. Proposition 218 will also limit the authority of local
governments to impose property-related assessments, fees and charges, requiring
that such assessments be limited to the special benefit conferred and
prohibiting their use for general governmental services. Proposition 218 also
allows voters to use their initiative power to reduce or repeal
previously-authorized taxes, assessments, fees and charges.
In 1988, State voters approved Proposition 87, which amended Article XVI of
the State Constitution to authorize the State Legislature to prohibit
redevelopment agencies from receiving any property tax revenues raised by
increased property taxes to repay bonded indebtedness of local government which
is not approved by voters on or before January 1, 1989. It is not possible to
predict whether the State Legislature will enact such a prohibition, nor is it
possible to predict the impact of Proposition 87 on redevelopment agencies and
their ability to make payments on outstanding debt obligations.
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<PAGE>
In November 1988, California voters approved Proposition 98. This initiative
requires that (i) revenues in excess of amounts permitted to be spent and which
would otherwise be returned by revision of tax rates or fee schedules, be
transferred and allocated (up to a maximum of 40%) to the State School Fund and
be expended solely for purposes of instructional improvement and accountability.
No such transfer or allocation of funds will be required if certain designated
state officials determine that annual student expenditures and class size meet
certain criteria as set forth in Proposition 98. Any funds allocated to the
State School Fund shall cause the appropriation limits to be annually increased
for any such allocation made in the prior year. Proposition 98 also requires the
State of California to provide a minimum level of funding for public schools and
community colleges. The initiative permits the enactment of legislation, by a
two-thirds vote, to suspend the minimum funding requirement for one year.
Certain tax-exempt securities in which the Fund may invest may be
obligations payable solely from the revenues of specific institutions, or may be
secured by specific properties, which are subject to provisions of California
law which could adversely affect the holders of such obligations. For example,
the revenues of California health care institutions may be subject to state
laws, and California law limits the remedies of a creditor secured by a mortgage
or deed of trust on real property.
California is the most populous state in the nation with a total population
estimated at 32.9 million. The State now comprises 12.3% of the nation's
population and 12.5% of its total personal income. Its economy is broad and
diversified with major concentrations in high technology research and
manufacturing, aerospace and defense-related manufacturing, trade,
entertainment, real estate, and financial services. After experiencing strong
growth throughout much of the 1980s, from 1990-1993 the State suffered through a
severe recession, the worst since the 1930's, heavily influenced by large
cutbacks in defense/aerospace industries and military base closures and a major
drop in real estate construction. California's economy has been recovering and
growing steadily stronger since the start of 1994, to the point where the
State's economic growth is outpacing the rest of the nation. The unemployment
rate, while still higher than the national average, fell to an average of 5.9%
in 1998, compared to over 10% at the worst of the recession. California's
economic recovery from the recession is continuing at a strong pace. Recent
economic reports indicate that, while the rate of economic growth in California
is expected to moderate over the next year, the increases in employment and
income may exceed those of the nation as a whole. The unsettled financial
situation occurring in certain Asian economies, and its spillover effect
elsewhere, may adversely affect the State's export-related industries and,
therefore, the State's rate of economic growth.
The Governor signed the 1998-99 Budget Act on August 21, 1998. The 1998-99
Budget Act is based on projected General Fund revenues and transfers of $57.0
billion (after giving effect to various tax reductions enacted in 1997 and
1998), a 4.2% increase from the revised 1997-98 figures. Special Fund revenues
were estimated at $14.3 billion. The revenue projections were based on the
Governor's May Revision to the 1998-99 Budget and may be overstated in light of
the possible effect on California's economic growth of worsening economic
problems in various international markets.
The Budget Act provides authority for expenditures of $57.3 billion from the
General Fund (a 7.3% increase from 1997-98), $14.7 billion from Special Funds,
and $3.4 billion from bond funds. The Budget Act projects a balance in the SFEU
at June 30, 1999 of $1.255 billion, a little more than 2% of General Fund
revenues. The Budget Act assumes the State will carry out its normal intra-year
cash flow borrowing in the amount of $1.7 billion of revenue anticipation notes
issued in October, 1998.
The most significant feature of the 1998-99 budget was agreement on a total
of $1.4 billion of tax cuts. The central element is a bill which provides for a
phased-in reduction of the Vehicle License Fee (VLF). Since the VLF is currently
transferred to cities and counties, the bill provides for the General Fund to
replace the lost revenues. Starting on January 1, 1999, the VLF will be reduced
by 25%, at a cost to the General Fund of approximately $500 million in the
1998-99 Fiscal Year and about $1 billion annually thereafter.
The Governor's proposed budget for fiscal year 1999-2000 proposes total
State spending of $76.2 billion (excluding the expenditure of federal funds and
selected bond funds), which is up 4.1% from the 1998-1999 budget. This total
includes $60.5 billion in General Fund spending (a 3.8% increase) and $15.7
billion in special funds spending. The Governor's proposed budget anticipates a
$415 million reserve by the close of the fiscal year. The proposed budget
addresses an anticipated funding shortfall of
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<PAGE>
$2.3 billion (which includes funds to rebuild the reserve) through a combination
of new state and federal resources, the rescheduling of certain expenditures,
under budgeting certain expenditures, spending cutbacks, and savings
assumptions.
As of November 1, 1998, the State had over $18.6 billion aggregate amount of
its general obligation bonds outstanding. General obligation bond authorizations
in an aggregate amount of approximately $5.7 billion remained unissued as of
November 1, 1998. At the November 3, 1998 election voters approved a bond
measure totaling $9.2 billion for public school construction and renovation, and
for higher education facilities. The State also builds and acquires capital
facilities through the use of lease purchase borrowing. As of November 1, 1998,
the State had approximately $6.5 billion of outstanding Lease-Purchase Debt.
In addition to the general obligation bonds, State agencies and authorities
had approximately $24.6 billion aggregate principal amount of revenue bonds and
notes outstanding as of September 30, 1998. Revenue bonds represent both
obligations payable from State revenue-producing enterprises and projects, which
are not payable from the General Fund, and conduit obligations payable only from
revenues paid by private users of facilities financed by such revenue bonds.
Such enterprises and projects include transportation projects, various public
works and exposition projects, educational facilities (including the California
State University and University of California systems), housing, health
facilities, and pollution control facilities.
Because of the State of California's budget problems, the State's General
Obligation bonds were downgraded in July 1994 to A1 from Aa by Moody's, to A
from A+ by S&P, and to A from AA by Fitch. Moody's, Fitch and S&P expressed
uncertainty in the State's ability to balance its budget by 1996. However, in
1996, citing California's improving economy and budget situation, both Fitch and
S&P raised their ratings from A to A+. In October, 1997, Fitch raised its rating
from A+ to AA- referring to the State's fundamental strengths, the extent of its
economic recovery and the return of financial stability. In October 1998,
Moody's raised its rating from A1 to Aa3 citing the State's continuing economic
recovery and a number of actions taken to improve the State's credit condition,
including the rebuilding of cash and budget reserves.
The State is a party to numerous legal proceedings, many of which normally
occur in governmental operations and which, if decided against the State, might
require the State to make significant future expenditures or impair future
revenue sources.
YEAR 2000. In October 1997 the Governor issued Executive Order W-163-97
stating that Year 2000 solutions would be a State priority and requiring each
agency of the State, no later than December 31, 1998, to address Year 2000
problems in their essential systems and protect those systems from corruption by
non-compliant systems, in accordance with the Department of Information
Technology's California 2000 Program. There can be no assurance that steps being
taken by state or local government agencies with respect to the Year 2000
problem will be sufficient to avoid any adverse impact upon the budgets or
operations of those agencies.
On December 6, 1994, Orange County, California, became the largest
municipality in the United States to file for protection under the Federal
bankruptcy laws. The filing stemmed from approximately $1.7 billion in losses
suffered by the County's investment pool due to investments in high risk
"derivative" securities. On June 12, 1996, it emerged from bankruptcy after the
successful sale of $880 million in municipal bonds allowed the county to pay off
the last of its creditors. On January 7, 1997, Orange County returned to the
municipal bond market with a $136 million bond issue maturing in 13 years at an
insured yield of 7.23%. In December, 1997, Moody's raised its ratings on $325
million of Orange County pension obligation bonds to Baa3 from Ba. In February
1998, Fitch assigned outstanding Orange County pension obligation bonds a BBB
rating.
Los Angeles County, the nation's largest county, has also experienced
financial difficulty. In August 1995 the credit rating of the county's long-term
bonds was downgraded for the third time since 1992 as a result of, and among
other things, severe operating deficits for the county's health care system. In
addition, the county was affected by an ongoing loss of revenue caused by state
property tax shift initiatives in 1993 through 1995. In April 1998, the Los
Angeles County Chief Administrative Officer proposed an approximately $13.2
billion 1998-99 budget, which would be 5.3% larger than the 1997-98
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<PAGE>
budget, and which would not require cuts in services and jobs to close a
projected deficit. In June 1998, the Los Angeles County Board of Supervisors
approved an approximately $13.6 billion 1998-99 budget, reserving the right to
make further changes to reflect revenue allocation decisions in the final State
budget. In December 1998, Moody's raised the ratings on the County's general
obligation bonds to A1 from A2. The City of Los Angeles is the largest city in
the county and its general obligation bonds are rated AA by S&P and Aa by
Moody's.
The effect of these various constitutional and statutory amendments and
budget developments upon the ability of California issuers to pay interest and
principal on their obligations remains unclear and in any event may depend upon
whether a particular California tax-exempt security is a general or limited
obligation bond and on the type of security provided for the bond. It is
possible that other measures affecting the taxing or spending authority of
California or its political subdivisions may be approved or enacted in the
future.
C. FUND POLICIES/INVESTMENT RESTRICTIONS
The investment objective, policies and restrictions listed below have been
adopted by the Fund as fundamental policies. Under the Investment Company Act of
1940 (the "Investment Company Act"), a fundamental policy may not be changed
without the vote of a majority of the outstanding voting securities of the Fund.
The Investment Company Act defines a majority as the lesser of (a) 67% or more
of the shares present at a meeting of shareholders, if the holders of 50% of the
outstanding shares of the Fund are present or represented by proxy; or (b) more
than 50% of the outstanding shares of the Fund.
In addition, for purposes of the following restrictions: (a) an "issuer" of
a security is the entity whose assets and revenues are committed to the payment
of interest and principal on that particular security, provided that the
guarantee of a security will be considered a separate security; (b) a "taxable
security" is any security the interest on which is subject to federal income
tax; and (c) all percentage limitations apply immediately after a purchase or
initial investment, and any subsequent change in any applicable percentage
resulting from market fluctuations or other changes in total or net assets does
not require elimination of any security from the portfolio.
The Fund will:
1. Seek to provide a high level of current income which is exempt from
both federal and California income tax, consistent with the preservation of
capital.
The Fund may not:
1. With respect to 75% of its total assets, purchase securities of any
issuer if immediately thereafter more than 5% of the Fund's total assets are
in the securities of any one issuer (other than obligations issued, or
guaranteed by, the United States Government, its agencies or
instrumentalities, or by the State of California or its political
subdivisions).
2. Purchase more than 10% of all outstanding taxable debt securities
of any one issuer (other than obligations issued, or guaranteed as to
principal and interest by, the United States Government, its agencies or
instrumentalities).
3. Invest more than 25% of the value of its total assets in taxable
securities of issuers in any one industry (industrial development and
pollution control bonds are grouped into industries based upon the business
in which the issuers of such obligations are engaged). This restriction does
not apply to obligations issued or guaranteed by the United States
Government, its agencies or instrumentalities or to municipal obligations,
including those issued by the State of California or its political
subdivisions.
4. Invest in common stock.
5. Write, purchase or sell puts, calls, or combinations thereof,
except for options on futures contracts or options on debt securities.
13
<PAGE>
6. Invest in securities of any issuer, if, to the knowledge of the
Fund, any officer or trustee of the Fund or of the Investment Manager owns
more than 1/2 of 1% of the outstanding securities of the issuer, and the
officers and trustees who own more than 1/2 of 1% own in the aggregate more
than 5% of the outstanding securities of the issuer.
7. Purchase or sell real estate or interests therein, although it may
purchase securities secured by real estate or interests therein.
8. Purchase or sell commodities except that the Fund may purchase
financial futures contracts and related options.
9. Borrow money, except that the Fund may borrow from a bank for
temporary or emergency purposes in amounts not exceeding 5% (taken at the
lower of cost or current value) of the value of its total assets (not
including the amount borrowed).
10. Pledge its assets or assign or otherwise encumber them except to
secure permitted borrowing. However, for the purpose of this restriction,
collateral arrangements with respect to the writing of options and
collateral arrangements with respect to initial margin for futures are not
deemed to be pledges of assets and neither such arrangements nor the
purchase or sale of futures are deemed to be the issuance of a senior
security as set forth in restriction 11.
11. Issue senior securities as defined in the Investment Company Act,
except insofar as the Fund may be deemed to have issued a senior security by
reason of: (a) entering into any repurchase agreement; (b) purchasing any
securities on a when-issued or delayed delivery basis; or (c) borrowing
money.
12. Make loans of money or securities, except: (a) by the purchase of
debt obligations; (b) by investment in repurchase agreements; and (c) by
lending its portfolio securities.
13. Make short sales of securities.
14. Purchase securities on margin, except for such short-term loans as
are necessary for the clearance of purchases of portfolio securities. The
deposit or payment by the Fund of initial or variation margin in connection
with futures contracts or related options thereon is not considered the
purchase of a security on margin.
15. Engage in the underwriting of securities, except insofar as the
Fund may be deemed an underwriter under the Securities Act in disposing of a
portfolio security.
16. Invest for the purpose of exercising control or management of any
other issuer.
17. Purchase oil, gas or other mineral leases, rights or royalty
contracts, or exploration or development programs.
18. Purchase securities of other investment companies, except in
connection with a merger, consolidation, reorganization or acquisition of
assets.
Notwithstanding any other investment policy or restriction, the Fund may
seek to achieve its investment objective by investing all or substantially all
of its assets in another investment company having substantially the same
investment objective and policies as the Fund.
III. MANAGEMENT OF THE FUND
- --------------------------------------------------------------------------------
A. BOARD OF TRUSTEES
The Board of Trustees of the Fund oversees the management of the Fund but
does not itself manage the Fund. The Trustees review various services provided
by or under the direction of the Investment Manager to ensure that the Fund's
general investment policies and programs are properly carried out. The Trustees
also conduct their review to ensure that administrative services are provided to
the Fund in a satisfactory manner.
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<PAGE>
Under state law, the duties of the Trustees are generally characterized as a
duty of loyalty and a duty of care. The duty of loyalty requires a Trustee to
exercise his or her powers in the interest of the Fund and not the Trustee's own
interest or the interest of another person or organization. A Trustee satisfies
his or her duty of care by acting in good faith with the care of an ordinarily
prudent person and in a manner the Trustee reasonably believes to be in the best
interest of the Fund and its shareholders.
B. MANAGEMENT INFORMATION
TRUSTEES AND OFFICERS. The Board of the Fund consists of eight (8)
Trustees. These same individuals also serve as directors or trustees for all of
the Morgan Stanley Dean Witter Funds. Six Trustees (75% of the total number)
have no affiliation or business connection with the Investment Manager or any of
its affiliated persons and do not own any stock or other securities issued by
the Investment Manager's parent company, MSDW. These are the "non-interested" or
"independent" Trustees. The other two Trustees (the "management Trustees") are
affiliated with the Investment Manager. All of the Independent Trustees also
serve as Independent Trustees of "Discover Brokerage Index Series," a mutual
fund for which the Investment Manager is the investment advisor. Three of the
six Independent Trustees are also Independent Trustees of certain other mutual
funds, referred to as the "TCW/DW Funds," for which MSDW Services Company is the
manager and TCW Funds Management, Inc. is the investment advisor.
The Trustees and executive officers of the Fund, their principal business
occupations during the last five years and their affiliations, if any, with the
Investment Manager, and with the 85 Morgan Stanley Dean Witter Funds, the 11
TCW/DW Funds and Discover Brokerage Index Series, are shown below.
<TABLE>
<CAPTION>
NAME, AGE, POSITION WITH FUND AND ADDRESS PRINCIPAL OCCUPATIONS DURING LAST FIVE YEARS
- ------------------------------------------------------ ----------------------------------------------------------
<S> <C>
Michael Bozic (58) ................................... Vice Chairman of Kmart Corporation (since December, 1998);
Trustee Director or Trustee of the Morgan Stanley Dean Witter
c/o Kmart Corporation Funds and Discover Brokerage Index Series; formerly
3100 West Big Beaver Road Chairman and Chief Executive Officer of Levitz Furniture
Troy, Michigan Corporation (November, 1995-November, 1998) and President
and Chief Executive Officer of Hills Department Stores
(May, 1991-July, 1995); formerly variously Chairman, Chief
Executive Officer, President and Chief Operating Officer
(1987-1991) of the Sears Merchandise Group of Sears,
Roebuck and Co.; Director of Eaglemark Financial Services,
Inc. and Weirton Steel Corporation.
Charles A. Fiumefreddo* (65) ......................... Chairman, Director or Trustee and Chief Executive Officer
Chairman of the Board, of the Morgan Stanley Dean Witter Funds, the TCW/DW Funds
Chief Executive Officer and Trustee and Discover Brokerage Index Series; formerly Chairman,
Two World Trade Center Chief Executive Officer and Director of the Investment
New York, New York Manager, the Distributor and MSDW Services Company;
Executive Vice President and Director of Dean Witter
Reynolds; Chairman and Director of the Transfer Agent;
formerly Director and/or officer of various MSDW sub-
sidiaries (until June, 1998).
</TABLE>
15
<PAGE>
<TABLE>
<CAPTION>
NAME, AGE, POSITION WITH FUND AND ADDRESS PRINCIPAL OCCUPATIONS DURING LAST FIVE YEARS
- ------------------------------------------------------ ----------------------------------------------------------
<S> <C>
Edwin J. Garn (66) ................................... Director or Trustee of the Morgan Stanley Dean Witter
Trustee Funds and Discover Brokerage Index Series; formerly United
c/o Huntsman Corporation States Senator (R-Utah) (1974-1992) and Chairman, Senate
500 Huntsman Way Banking Committee (1980-1986); formerly Mayor of Salt Lake
Salt Lake City, Utah City, Utah (1971-1974); formerly Astronaut, Space Shuttle
Discovery (April 12-19, 1985); Vice Chairman, Huntsman
Corporation; Director of Franklin Covey (time management
systems), BMW Bank of North America, Inc. (industrial loan
corporation), United Space Alliance (joint venture between
Lockheed Martin and the Boeing Company) and Nuskin Asia
Pacific (multilevel marketing); member of the board of
various civic and charitable organizations.
Wayne E. Hedien (65) ................................. Retired; Director or Trustee of the Morgan Stanley Dean
Trustee Witter Funds and Discover Brokerage Index Series; Director
c/o Gordon Altman Butowsky of The PMI Group, Inc. (private mortgage insurance);
Weitzen Shalov & Wein Trustee and Vice Chairman of The Field Museum of Natural
Counsel to the Independent Trustees History; formerly associated with the Allstate Companies
114 West 47th Street (1966-1994), most recently as Chairman of The Allstate
New York, New York Corporation (March, 1993-December, 1994) and Chairman and
Chief Executive Officer of its wholly-owned subsidiary,
Allstate Insurance Company (July, 1989-December, 1994);
director of various other business and charitable
organizations.
Dr. Manuel H. Johnson (50) ........................... Senior Partner, Johnson Smick International, Inc., a
Trustee consulting firm; Co-Chairman and a founder of the Group of
c/o Johnson Smick International, Inc. Seven Council (G7C), an international economic commission;
1133 Connecticut Avenue, N.W. Chairman of the Audit Committee and Director or Trustee of
Washington, D.C. the Morgan Stanley Dean Witter Funds, the TCW/DW Funds and
Discover Brokerage Index Series; Director of Greenwich
Capital Markets, Inc. (broker-dealer) and NVR, Inc. (home
construction); Chairman and Trustee of the Financial
Accounting Foundation (oversight organization of the
Financial Accounting Standards Board); formerly Vice
Chairman of the Board of Governors of the Federal Reserve
System (1986-1990) and Assistant Secretary of the U.S.
Treasury.
Michael E. Nugent (62) ............................... General Partner, Triumph Capital, L.P., a private
Trustee investment partnership; Chairman of the Insurance
c/o Triumph Capital, L.P. Committee and Director or Trustee of the Morgan Stanley
237 Park Avenue Dean Witter Funds, the TCW/DW Funds and Discover Brokerage
New York, New York Index Series; formerly Vice President, Bankers Trust
Company and BT Capital Corporation (1984-1988); director
of various business organizations.
</TABLE>
16
<PAGE>
<TABLE>
<CAPTION>
NAME, AGE, POSITION WITH FUND AND ADDRESS PRINCIPAL OCCUPATIONS DURING LAST FIVE YEARS
- ------------------------------------------------------ ----------------------------------------------------------
<S> <C>
Philip J. Purcell* (55) .............................. Chairman of the Board of Directors and Chief Executive
Trustee Officer of MSDW, Dean Witter Reynolds and Novus Credit
1585 Broadway Services Inc.; Director of the Distributor; Director or
New York, New York Trustee of the Morgan Stanley Dean Witter Funds and
Discover Brokerage Index Series; Director and/or officer
of various MSDW subsidiaries.
John L. Schroeder (68) ............................... Retired; Chairman of the Derivatives Committee and
Trustee Director or Trustee of the Morgan Stanley Dean Witter
c/o Gordon Altman Butowsky Funds, the TCW/DW Funds and Discover Brokerage Index
Weitzen Shalov & Wein Series; Director of Citizens Utilities Company; formerly
Counsel to the Independent Trustees Executive Vice President and Chief Investment Officer of
114 West 47th Street the Home Insurance Company (August, 1991-September, 1995).
New York, New York
Mitchell M. Merin (45) ............................... President and Chief Operating Officer of Asset Management
President of MSDW (since December, 1998); President and Director
Two World Trade Center (since April, 1997) and Chief Executive Officer (since
New York, New York June, 1998) of the Investment Manager and MSDW Services
Company; Chairman, Chief Executive Officer and Director of
the Distributor (since June, 1998); Chairman and Chief
Executive Officer (since June, 1998) and Director (since
January, 1998) of the Transfer Agent; Director of various
MSDW subsidiaries; President of the Morgan Stanley Dean
Witter Funds, the TCW/DW Funds and Discover Brokerage
Index Series (since May, 1999); previously Chief Strategic
Officer of the Investment Manager and MSDW Services
Company and Executive Vice President of the Distributor
(April, 1997-June, 1998), Vice President of the Morgan
Stanley Dean Witter Funds, the TCW/DW Funds and Discover
Brokerage Index Series (May, 1997-April, 1999), and
Executive Vice President of Dean Witter, Discover & Co.
Barry Fink (44) ...................................... Senior Vice President (since March, 1997) and Secretary
Vice President, and General Counsel (since February, 1997) and Director
Secretary and General Counsel (since July, 1998) of the Investment Manager and MSDW
Two World Trade Center Services Company; Senior Vice President (since March,
New York, New York 1997) and Assistant Secretary and Assistant General
Counsel (since February, 1997) of the Distributor;
Assistant Secretary of Dean Witter Reynolds (since August,
1996); Vice President, Secretary and General Counsel of
the Morgan Stanley Dean Witter Funds and the TCW/DW Funds
(since February, 1997); Vice President, Secretary and
General Counsel of Discover Brokerage Index Series;
previously First Vice President (June, 1993-February,
1997), Vice President and Assistant Secretary and
Assistant General Counsel of the Investment Manager and
MSDW Services Company and Assistant Secretary of the Mor-
gan Stanley Dean Witter Funds and the TCW/DW Funds.
</TABLE>
17
<PAGE>
<TABLE>
<CAPTION>
NAME, AGE, POSITION WITH FUND AND ADDRESS PRINCIPAL OCCUPATIONS DURING LAST FIVE YEARS
- ------------------------------------------------------ ----------------------------------------------------------
<S> <C>
James F. Willison (55) ............................... Senior Vice President of the Investment Manager; Vice
Vice President President of various Morgan Stanley Dean Witter Funds.
Two World Trade Center
New York, New York
Joseph R. Arcieri (50) ............................... Vice President of the Investment Manager; Vice President
Vice President of various Morgan Stanley Dean Witter Funds.
Two World Trade Center
New York, New York
Thomas F. Caloia (53) ................................ First Vice President and Assistant Treasurer of the
Treasurer Investment Manager and MSDW Services Company; Treasurer of
Two World Trade Center the Morgan Stanley Dean Witter Funds, the TCW/DW Funds and
New York, New York Discover Brokerage Index Series.
</TABLE>
- ------------------------
* Denotes Trustees who are "interested persons" of the Fund as defined by the
Investment Company Act.
In addition, RONALD E. ROBISON, Executive Vice President, Chief
Administrative Officer and Director of the Investment Manager and MSDW Services
Company, ROBERT S. GIAMBRONE, Senior Vice President of the Investment Manager,
MSDW Services Company, the Distributor and the Transfer Agent and Director of
the Transfer Agent, and JOSEPH J. MCALINDEN, Executive Vice President and Chief
Investment Officer of the Investment Manager and Director of the Transfer Agent,
and PETER M. AVELAR, JONATHAN R. PAGE and JAMES F. WILLISON, Senior Vice
Presidents of the Investment Manager, and GERARD J. LIAN and KATHERINE H.
STROMBERG, Vice Presidents of the Investment Manager, are Vice Presidents of the
Fund.
In addition, FRANK BRUTTOMESSO, MARILYN K. CRANNEY, LOU ANNE D. MCINNIS,
CARSTEN OTTO and RUTH ROSSI, First Vice Presidents and Assistant General
Counsels of the Investment Manager and MSDW Services Company, and TODD LEBO,
Vice President and Assistant General Counsel of the Investment Manager and MSDW
Services Company, are Assistant Secretaries of the Fund.
INDEPENDENT TRUSTEES AND THE COMMITTEES. Law and regulation establish both
general guidelines and specific duties for the Independent Trustees. The Morgan
Stanley Dean Witter Funds seek as Independent Trustees individuals of
distinction and experience in business and finance, government service or
academia; these are people whose advice and counsel are in demand by others and
for whom there is often competition. To accept a position on the Funds' Boards,
such individuals may reject other attractive assignments because the Funds make
substantial demands on their time. All of the Independent Trustees serve as
members of the Audit Committee. In addition, three of the Trustees, including
two Independent Trustees, serve as members of the Derivatives Committee and the
Insurance Committee.
The Independent Trustees are charged with recommending to the full Board
approval of management, advisory and administration contracts, Rule 12b-1 plans
and distribution and underwriting agreements; continually reviewing Fund
performance; checking on the pricing of portfolio securities, brokerage
commissions, transfer agent costs and performance, and trading among Funds in
the same complex; and approving fidelity bond and related insurance coverage and
allocations, as well as other matters that arise from time to time. The
Independent Trustees are required to select and nominate individuals to fill any
Independent Trustee vacancy on the Board of any Fund that has a Rule 12b-1 plan
of distribution. Most of the Morgan Stanley Dean Witter Funds have a Rule 12b-1
plan.
The Audit Committee is charged with recommending to the full Board the
engagement or discharge of the Fund's independent accountants; directing
investigations into matters within the scope of the independent accountants'
duties, including the power to retain outside specialists; reviewing with the
independent accountants the audit plan and results of the auditing engagement;
approving professional services provided by the independent accountants and
other accounting firms prior to the performance of the services; reviewing the
independence of the independent accountants; considering the range of audit and
non-audit fees; reviewing the adequacy of the Fund's system of internal
controls; and preparing and submitting Committee meeting minutes to the full
Board.
18
<PAGE>
The Board of each Fund has a Derivatives Committee to approve parameters for
and monitor the activities of the Fund with respect to derivative investments,
if any, made by the Fund.
Finally, the Board of each Fund has formed an Insurance Committee to review
and monitor the insurance coverage maintained by the Fund.
ADVANTAGES OF HAVING SAME INDIVIDUALS AS INDEPENDENT TRUSTEES FOR ALL MORGAN
STANLEY DEAN WITTER FUNDS. The Independent Trustees and the Funds' management
believe that having the same Independent Trustees for each of the Morgan Stanley
Dean Witter Funds avoids the duplication of effort that would arise from having
different groups of individuals serving as Independent Trustees for each of the
Funds or even of sub-groups of Funds. They believe that having the same
individuals serve as Independent Trustees of all the Funds tends to increase
their knowledge and expertise regarding matters which affect the Fund complex
generally and enhances their ability to negotiate on behalf of each Fund with
the Fund's service providers. This arrangement also precludes the possibility of
separate groups of Independent Trustees arriving at conflicting decisions
regarding operations and management of the Funds and avoids the cost and
confusion that would likely ensue. Finally, having the same Independent Trustees
serve on all Fund Boards enhances the ability of each Fund to obtain, at modest
cost to each separate Fund, the services of Independent Trustees, of the
caliber, experience and business acumen of the individuals who serve as
Independent Trustees of the Morgan Stanley Dean Witter Funds.
TRUSTEE AND OFFICER INDEMNIFICATION. The Fund's Declaration of Trust
provides that no Trustee, officer, employee or agent of the Fund is liable to
the Fund or to a shareholder, nor is any Trustee, officer, employee or agent
liable to any third persons in connection with the affairs of the Fund, except
as such liability may arise from his/her or its own bad faith, willful
misfeasance, gross negligence or reckless disregard of his/her or its duties. It
also provides that all third persons shall look solely to the Fund property for
satisfaction of claims arising in connection with the affairs of the Fund. With
the exceptions stated, the Declaration of Trust provides that a Trustee,
officer, employee or agent is entitled to be indemnified against all liability
in connection with the affairs of the Fund.
C. COMPENSATION
The Fund pays each Independent Trustee an annual fee of $800 plus a per
meeting fee of $50 for meetings of the Board of Trustees, the Independent
Trustees or Committees of the Board of Trustees attended by the Trustee (the
Fund pays the Chairman of the Audit Committee an additional annual fee of $750,
and the Chairman of the Derivatives and Insurance Committees additional annual
fees of $500). If a Board meeting and a meeting of the Independent Trustees or a
Committee meeting, or a meeting of the Independent Trustees and/or more than one
Committee meeting, take place on a single day, the Trustees are paid a single
meeting fee by the Fund. The Fund also reimburses such Trustees for travel and
other out-of-pocket expenses incurred by them in connection with attending such
meetings. Trustees and officers of the Fund who are or have been employed by the
Investment Manager or an affiliated company receive no compensation or expense
reimbursement from the Fund for their services as Trustee.
The following table illustrates the compensation that the Fund paid to its
Independent Trustees for the fiscal year ended December 31, 1998.
FUND COMPENSATION
<TABLE>
<CAPTION>
AGGREGATE
COMPENSATION
NAME OF INDEPENDENT TRUSTEE FROM THE FUND
- -------------------------------------------------------------- ---------------
<S> <C>
Michael Bozic................................................. $1,450
Edwin J. Garn................................................. 1,600
Wayne E. Hedien............................................... 1,600
Dr. Manuel H. Johnson......................................... 1,550
Michael E. Nugent............................................. 1,600
John L. Schroeder............................................. 1,600
</TABLE>
19
<PAGE>
The following table illustrates the compensation paid to the Fund's
Independent Trustees for the calendar year ended December 31, 1998 for services
to the 85 Morgan Stanley Dean Witter Funds and, in the case of Messrs. Johnson,
Nugent and Schroeder, the 11 TCW/DW Funds that were in operation at December 31,
1998. With respect to Messrs. Johnson, Nugent and Schroeder, the TCW/DW Funds
are included solely because of a limited exchange privilege between those Funds
and five Morgan Stanley Dean Witter Money Market Funds. No compensation was paid
to the Fund's Independent Trustees by Discover Brokerage Index Series for the
calendar year ended December 31, 1998.
CASH COMPENSATION FROM MORGAN STANLEY DEAN WITTER FUNDS AND TCW/DW FUNDS
<TABLE>
<CAPTION>
TOTAL CASH
COMPENSATION
FOR SERVICE FOR SERVICES
AS DIRECTOR OR TO
TRUSTEE AND FOR SERVICE AS 85 MORGAN
COMMITTEE MEMBER TRUSTEE AND STANLEY DEAN
OF 85 MORGAN COMMITTEE MEMBER WITTER FUNDS
NAME OF STANLEY DEAN OF 11 TCW/DW AND 11 TCW/DW
INDEPENDENT TRUSTEE WITTER FUNDS FUNDS FUNDS
- --------------------------- ---------------- ---------------- -------------
<S> <C> <C> <C>
Michael Bozic.............. $120,150 -- $120,150
Edwin J. Garn.............. 132,450 -- 132,450
Wayne E. Hedien............ 132,350 -- 132,350
Dr. Manuel H. Johnson...... 128,400 62,331 190,731
Michael E. Nugent.......... 132,450 62,131 194,581
John L. Schroeder.......... 132,450 64,731 197,181
</TABLE>
As of the date of this STATEMENT OF ADDITIONAL INFORMATION, 55 of the Morgan
Stanley Dean Witter Funds, including the Fund, have adopted a retirement program
under which an Independent Trustee who retires after serving for at least five
years (or such lesser period as may be determined by the Board) as an
Independent Director or Trustee of any Morgan Stanley Dean Witter Fund that has
adopted the retirement program (each such Fund referred to as an "Adopting Fund"
and each such Trustee referred to as an "Eligible Trustee") is entitled to
retirement payments upon reaching the eligible retirement age (normally, after
attaining age 72). Annual payments are based upon length of service.
Currently, upon retirement, each Eligible Trustee is entitled to receive
from the Adopting Fund, commencing as of his or her retirement date and
continuing for the remainder of his or her life, an annual retirement benefit
(the "Regular Benefit") equal to 30.22% of his or her Eligible Compensation plus
0.5036667% of such Eligible Compensation for each full month of service as an
Independent Director or Trustee of any Adopting Fund in excess of five years up
to a maximum of 60.44% after ten years of service. The foregoing percentages may
be changed by the Board.(1) "Eligible Compensation" is one-fifth of the total
compensation earned by such Eligible Trustee for service to the Adopting Fund in
the five year period prior to the date of the Eligible Trustee's retirement.
Benefits under the retirement program are not secured or funded by the Adopting
Funds.
20
<PAGE>
The following table illustrates the retirement benefits accrued to the
Fund's Independent Trustees by the Fund for the year ended December 31, 1998 and
by the 55 Morgan Stanley Dean Witter Funds (including the Fund) for the year
ended December 31, 1998, and the estimated retirement benefits for the
Independent Trustees, to commence upon their retirement, from the Fund as of
December 31, 1998 and from the 55 Morgan Stanley Dean Witter Funds as of
December 31, 1998.
RETIREMENT BENEFITS FROM THE FUND AND ALL MORGAN STANLEY DEAN WITTER FUNDS
<TABLE>
<CAPTION>
FOR ALL ADOPTING FUNDS RETIREMENT BENEFITS ESTIMATED ANNUAL
--------------------------------- ACCRUED AS EXPENSES BENEFITS
ESTIMATED UPON RETIREMENT(2)
CREDITED YEARS ESTIMATED --------------------- -------------------
OF SERVICE AT PERCENTAGE OF BY ALL FROM FROM ALL
RETIREMENT ELIGIBLE BY THE ADOPTING THE ADOPTING
NAME OF INDEPENDENT TRUSTEE (MAXIMUM 10) COMPENSATION FUND FUNDS FUND FUNDS
- ----------------------------------- --------------- --------------- ------ ------------ -------- --------
<S> <C> <C> <C> <C> <C> <C>
Michael Bozic...................... 10 60.44% $ 396 $ 22,377 $ 997 $ 52,250
Edwin J. Garn...................... 10 60.44 599 35,225 997 52,250
Wayne E. Hedien.................... 9 51.37 740 41,979 848 44,413
Dr. Manuel H. Johnson.............. 10 60.44 240 14,047 997 52,250
Michael E. Nugent.................. 10 60.44 421 25,336 997 52,250
John L. Schroeder.................. 8 50.37 807 45,117 838 44,343
</TABLE>
- ------------------------
(1) An Eligible Trustee may elect alternative payments of his or her retirement
benefits based upon the combined life expectancy of the Eligible Trustee and
his or her spouse on the date of such Eligible Trustee's retirement. In
addition, the Eligible Trustee may elect that the surviving spouse's
periodic payment of benefits will be equal to a lower percentage of the
periodic amount when both spouses were alive. The amount estimated to be
payable under this method, through the remainder of the later of the lives
of the Eligible Trustee and spouse, will be the actuarial equivalent of the
Regular Benefit.
(2) Based on current levels of compensation. Amount of annual benefits also
varies depending on the Trustee's elections described in Footnote 1 above.
IV. CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES
- --------------------------------------------------------------------------------
The following owned 5% or more of the outstanding shares of Class A on April
6, 1999: Thomas J. McMurray Jr. & Gretha K. McMurray JTTEN, PO Box 1032, Eureka,
CA 95502-1032--33.12%; Harry Lewis & Janet J. Lewis, TTEES F/T Harry & Janet
Lewis, Revocable TR DTD 3/29/95 a/c #1, PO Box 352, Pebble Beach, CA
93953-0352--16.58%; Lorin A. Pennington & Martha Jane Pennington JTTEN, 4055
Lopez Dr., Arroyo Grande, CA 93420-4983--8.67%; Lynda Trelut & James Trelut
JTTEN, 1617 El Dorado Dr., Gilroy, CA 95020-3754--8.37%; Leo J. Tauber & Lucy C.
Tauber TTEE of the Tauber Family Rev. Trust DTD 7/3/90, 317 Carol Dr., Ventura,
CA 93003-1710--7.00%; Sylvia Coe Tolk, 852 Green St., San Francisco, CA
94133-3717--6.63%. The following owned 5% or more of the outstanding shares of
Class C on April 6, 1999: Donald B. Schmickrath & Melody Schmickrath TTEES O/T
Schmickrath Family Rev. Trust DTD 10/7/96, 12510 Barley Hill Rd., Los Altos
Hills, CA 94024-5211--8.63%; Janice Pruett Gouveia TTEE of the Dempsey R.
Parsley Trust DTD 2/13/91, 4713 Newport Ave, San Diego, CA 92107-2204--6.27%.
The following owned 5% or more of the outstanding shares of Class D on April 6,
1999: Robert H. Killen TTEE for the Robert H. Margaret R. Killen Trust DTD
6/12/86, PO Box 547, South Pasadena, CA 91031-0547--24.92%; Nadine S., Robert
J., & Vicki Rushakoff CO-TTEES F/T Rushakoff Survivors Trust DTD 5/20/97, 221
Morningside Dr. San Francisco, CA 94132-1240--14.01%; Morgan Stanley Dean Witter
Trust FSB Agent for American Baptist Homes Foundation of the West Inc., TTEE FBO
Stokes #2 PO Box 503, Jersey City, NJ 07311--13.71%; Ben Aliza & Barbara Aliza
JTTEN, PO Box 1190, Kenwood, CA 95452-1190--8.22%; Morgan Stanley Dean Witter
Trust FSB Agent for American Baptist Homes Foundation of the West Inc., TTEE FBO
Stokes #1 PO Box 503, Jersey City, NJ 07311-- 7.28%; Frank N. Wright Jr. PO Box
1527, Monterey, CA 93942-1527--5.42%; William P. Tallon & Linda M. Tallon JTTEN,
427 E. Central Ave., San Gabriel, CA 91776-3020--5.39%; DB Colombo, 959 A Calle
Aragon, Laguna Hills, CA 92653-3420--5.29%.
21
<PAGE>
As of the date of this STATEMENT OF ADDITIONAL INFORMATION, the aggregate
number of shares of beneficial interest of the Fund owned by the Fund's officers
and Trustees as a group was less than 1% of the Fund's shares of beneficial
interest outstanding.
V. INVESTMENT MANAGEMENT AND OTHER SERVICES
- --------------------------------------------------------------------------------
A. INVESTMENT MANAGER
The Investment Manager to the Fund is Morgan Stanley Dean Witter Advisors
Inc., a Delaware corporation, whose address is Two World Trade Center, New York,
New York 10048. The Investment Manager is a wholly-owned subsidiary of MSDW, a
Delaware corporation. MSDW is a preeminent global financial services firm that
maintains leading market positions in each of its three primary businesses:
securities, asset management and credit services.
Pursuant to an Investment Management Agreement (the "Management Agreement")
with the Investment Manager, the Fund has retained the Investment Manager to
provide administrative services and manage the investment of the Fund's assets,
including the placing of orders for the purchase and sale of portfolio
securities. The Fund pays the Investment Manager monthly compensation calculated
daily by applying the following annual rates to the net assets of the Fund
determined as of the close of each business day: 0.55% to the portion of daily
net assets not exceeding $500 million; 0.525% to the portion of daily net assets
exceeding $500 million but not exceeding $750 million; 0.50% to the portion of
daily net assets exceeding $750 million but not exceeding $1 billion; and 0.475%
of the portion of the daily net assets exceeding $1 billion. The management fee
is allocated among the Classes pro rata based on the net assets of the Fund
attributable to each Class. For the fiscal years ended December 31, 1996, 1997
and 1998, the Investment Manager accrued total compensation under the Management
Agreement in the amounts of $5,313,150, $4,966,928 and $4,871,646, respectively.
The Investment Manager has retained its wholly-owned subsidiary, MSDW
Services Company, to perform administrative services for the Fund.
B. PRINCIPAL UNDERWRITER
The Fund's principal underwriter is the Distributor (which has the same
address as the Investment Manager). In this capacity, the Fund's shares are
distributed by the Distributor. The Distributor has entered into a selected
dealer agreement with Dean Witter Reynolds, which through its own sales
organization sells shares of the Fund. In addition, the Distributor may enter
into similar agreements with other selected broker-dealers. The Distributor, a
Delaware corporation, is a wholly-owned subsidiary of MSDW.
The Distributor bears all expenses it may incur in providing services under
the Distribution Agreement. These expenses include the payment of commissions
for sales of the Fund's shares and incentive compensation to Financial Advisors.
The Distributor also pays certain expenses in connection with the distribution
of the Fund's shares, including the costs of preparing, printing and
distributing advertising or promotional materials, and the costs of printing and
distributing prospectuses and supplements thereto used in connection with the
offering and sale of the Fund's shares. The Fund bears the costs of initial
typesetting, printing and distribution of prospectuses and supplements thereto
to shareholders. The Fund also bears the costs of registering the Fund and its
shares under federal and state securities laws and pays filing fees in
accordance with state securities laws.
The Fund and the Distributor have agreed to indemnify each other against
certain liabilities, including liabilities under the Securities Act. Under the
Distribution Agreement, the Distributor uses its best efforts in rendering
services to the Fund, but in the absence of willful misfeasance, bad faith,
gross negligence or reckless disregard of its obligations, the Distributor is
not liable to the Fund or any of its shareholders for any error of judgment or
mistake of law or for any act or omission or for any losses sustained by the
Fund or its shareholders.
22
<PAGE>
C. SERVICES PROVIDED BY THE INVESTMENT MANAGER AND FUND EXPENSES PAID BY THIRD
PARTIES
The Investment Manager manages the investment of the Fund's assets,
including the placing of orders for the purchase and sale of portfolio
securities. The Investment Manager obtains and evaluates the information and
advice relating to the economy, securities markets, and specific securities as
it considers necessary or useful to continuously manage the assets of the Fund
in a manner consistent with its investment objective.
Under the terms of the Management Agreement, in addition to managing the
Fund's investments, the Investment Manager maintains certain of the Fund's books
and records and furnishes, at its own expense, the office space, facilities,
equipment, clerical help, bookkeeping and certain legal services as the Fund may
reasonably require in the conduct of its business, including the preparation of
prospectuses, proxy statements and reports required to be filed with federal and
state securities commissions (except insofar as the participation or assistance
of independent accountants and attorneys is, in the opinion of the Investment
Manager, necessary or desirable). In addition, the Investment Manager pays the
salaries of all personnel, including officers of the Fund, who are employees of
the Investment Manager. The Investment Manager also bears the cost of telephone
service, heat, light, power and other utilities provided to the Fund.
Expenses not expressly assumed by the Investment Manager under the
Management Agreement or by the Distributor, will be paid by the Fund. These
expenses will be allocated among the four Classes of shares pro rata based on
the net assets of the Fund attributable to each Class, except as described
below. Such expenses include, but are not limited to: expenses of the Plan of
Distribution pursuant to Rule 12b-1; charges and expenses of any registrar,
custodian, stock transfer and dividend disbursing agent; brokerage commissions;
taxes; engraving and printing share certificates; registration costs of the Fund
and its shares under federal and state securities laws; the cost and expense of
printing, including typesetting, and distributing prospectuses of the Fund and
supplements thereto to the Fund's shareholders; all expenses of shareholders'
and Trustees' meetings and of preparing, printing and mailing of proxy
statements and reports to shareholders; fees and travel expenses of Trustees or
members of any advisory board or committee who are not employees of the
Investment Manager or any corporate affiliate of the Investment Manager; all
expenses incident to any dividend, withdrawal or redemption options; charges and
expenses of any outside service used for pricing of the Fund's shares; fees and
expenses of legal counsel, including counsel to the Trustees who are not
interested persons of the Fund or of the Investment Manager (not including
compensation or expenses of attorneys who are employees of the Investment
Manager); fees and expenses of the Fund's independent accountants; membership
dues of industry associations; interest on Fund borrowings; postage; insurance
premiums on property or personnel (including officers and Trustees) of the Fund
which inure to its benefit; extraordinary expenses (including, but not limited
to, legal claims and liabilities and litigation costs and any indemnification
relating thereto); and all other costs of the Fund's operation. The 12b-1 fees
relating to a particular Class will be allocated directly to that Class. In
addition, other expenses associated with a particular Class (except advisory or
custodial fees) may be allocated directly to that Class, provided that such
expenses are reasonably identified as specifically attributable to that Class
and the direct allocation to that Class is approved by the Trustees.
The Management Agreement provides that in the absence of willful
misfeasance, bad faith, gross negligence or reckless disregard of its
obligations thereunder, the Investment Manager is not liable to the Fund or any
of its investors for any act or omission by the Investment Manager or for any
losses sustained by the Fund or its investors.
The Management Agreement will remain in effect from year to year, provided
continuance of the Management Agreement is approved at least annually by the
vote of the holders of a majority, as defined in the Investment Company Act, of
the outstanding shares of the Fund, or by the Trustees; provided that in either
event such continuance is approved annually by the vote of a majority of the
Trustees.
23
<PAGE>
D. DEALER REALLOWANCES
Upon notice to selected broker-dealers, the Distributor may reallow up to
the full applicable front-end sales charge during periods specified in such
notice. During periods when 90% or more of the sales charge is reallowed, such
selected broker-dealers may be deemed to be underwriters as that term is defined
in the Securities Act.
E. RULE 12b-1 PLAN
The Fund has adopted a Plan of Distribution pursuant to Rule 12b-1 under the
Investment Company Act (the "Plan") pursuant to which each Class, other than
Class D, pays the Distributor compensation accrued daily and payable monthly at
the following annual rates: 0.25% and 0.75% of the average daily net assets of
Class A and Class C, respectively, and, with respect to Class B, 0.75% of the
lesser of: (a) the average daily aggregate gross sales of the Fund's Class B
shares since the inception of the Fund (not including reinvestment of dividends
or capital gains distributions), less the average daily aggregate net asset
value of the Fund's Class B shares redeemed since the Fund's inception upon
which a contingent deferred sales charge has been imposed or upon which such
charge has been waived; or (b) the average daily net assets of Class B.
The Distributor also receives the proceeds of front-end sales charges
("FSCs") and of contingent deferred sales charges ("CDSCs") imposed on certain
redemptions of shares, which are separate and apart from payments made pursuant
to the Plan. The Distributor has informed the Fund that it and/or Dean Witter
Reynolds received the proceeds of CDSCs and FSCs, for the last three fiscal
years ended December 31, in approximate amounts as provided in the table below
(the Distributor did not retain any of these amounts).
<TABLE>
<CAPTION>
1998 1997 1996
----------------------- ------------------------- -------------------------
<S> <C> <C> <C> <C> <C> <C>
Class A.......................... FSCs:(1) $ 43,401 FSCs: $ 6,670(2) FSCs: 0(2)
CDSCs: 0 CDSCs: 0(2) CDSCs: 0(2)
Class B.......................... CDSCs: $ 694,975 CDSCs: $ 1,100,000 CDSCs: $ 1,325,000
Class C.......................... CDSCs: $ 1,943 CDSCs: $ 237(2) CDSCs: 0(2)
</TABLE>
- ------------------------
(1) FSCs apply to Class A only.
(2) This Class commenced operations on July 28, 1997.
The Distributor has informed the Fund that the entire fee payable by Class A
and a portion of the fees payable by each of Class B and Class C each year
pursuant to the Plan equal to 0.20% of the average daily net assets of Class B
and 0.25% of the average daily net assets of Class C are currently each
characterized as a "service fee" under the Rules of the National Association of
Securities Dealers, Inc. (of which the Distributor is a member). The "service
fee" is a payment made for personal service and/or the maintenance of
shareholder accounts. The remaining portion of the Plan fees payable by a Class,
if any, is characterized as an "asset-based sales charge" as such is defined by
the Rules of the Association.
Under the Plan and as required by Rule 12b-1, the Trustees receive and
review promptly after the end of each calendar quarter a written report provided
by the Distributor of the amounts expended under the Plan and the purpose for
which such expenditures were made. Class B shares of the Fund accrued amounts
payable to the Distributor under the Plan, during the fiscal year ended December
31, 1998, of $6,763,732. This amount is equal to 0.75% of the Fund's average
daily net assets for the fiscal year and was calculated pursuant to clause (b)
of the compensation formula under the Plan. The Distributor rebated a total of
3,465,883 back to the Fund. Therefore, the total amount paid by the Distributor
was $3,297,849, which amount is equal to 0.37% of the Fund's average daily net
assets for the year. For the fiscal year ended December 31, 1998, Class A and
Class C shares of the Fund accrued payments under the Plan amounting to $6,337
and $53,763, respectively, which amounts are equal to 0.25% and 0.75% of the
average daily net assets of Class A and Class C, respectively, for the fiscal
year.
24
<PAGE>
The Plan was adopted in order to permit the implementation of the Fund's
method of distribution. Under this distribution method the Fund offers four
Classes, each with a different distribution arrangement.
With respect to Class A shares, Dean Witter Reynolds compensates its
Financial Advisors by paying them, from proceeds of the FSC, commissions for the
sale of Class A shares, currently a gross sales credit of up to 4.0% of the
amount sold (except as provided in the following sentence) and an annual
residual commission, currently a residual of up to 0.20% of the current value of
the respective accounts for which they are the Financial Advisors or dealers of
record in all cases. On orders of $1 million or more (for which no sales charge
was paid), the Investment Manager compensates Financial Advisors by paying them,
from its own funds, a gross sales credit of 1.0% of the amount sold.
With respect to Class B shares, Dean Witter Reynolds compensates its
Financial Advisors by paying them, from its own funds, commissions for the sale
of Class B shares, currently a gross sales credit of up to 4.0% of the amount
sold and an annual residual commission, currently a residual of up to 0.20% of
the current value (not including reinvested dividends or distributions) of the
amount sold in all cases.
With respect to Class C shares, Dean Witter Reynolds compensates its
Financial Advisors by paying them, from its own funds, commissions for the sale
of Class C shares, currently a gross sales credit of up to 1.0% of the amount
sold and an annual residual commission, currently up to 0.75% of the current
value of the respective accounts for which they are the Financial Advisors of
record.
With respect to Class D shares other than shares held by participants in the
Investment Manager's mutual fund asset allocation program, the Investment
Manager compensates Dean Witter Reynolds's Financial Advisors by paying them,
from its own funds, commissions for the sale of Class D shares, currently a
gross sales credit of up to 1.0% of the amount sold. There is a chargeback of
100% of the amount paid if the Class D shares are redeemed in the first year and
a chargeback of 50% of the amount paid if the Class D shares are redeemed in the
second year after purchase. The Investment Manager also compensates Dean Witter
Reynolds's Financial Advisors by paying them, from its own funds, an annual
residual commission, currently up to 0.10% of the current value of the
respective accounts for which they are the Financial Advisors of record (not
including accounts of participants in the Investment Manager's mutual fund asset
allocation program).
The gross sales credit is a charge which reflects commissions paid by Dean
Witter Reynolds to its Financial Advisors and Dean Witter Reynolds's
Fund-associated distribution-related expenses, including sales compensation, and
overhead and other branch office distribution-related expenses including (a) the
expenses of operating Dean Witter Reynolds's branch offices in connection with
the sale of Fund shares, including lease costs, the salaries and employee
benefits of operations and sales support personnel, utility costs,
communications costs and the costs of stationery and supplies; (b) the costs of
client sales seminars; (c) travel expenses of mutual fund sales coordinators to
promote the sale of Fund shares; and (d) other expenses relating to branch
promotion of Fund sales.
The distribution fee that the Distributor receives from the Fund under the
Plan, in effect, offsets distribution expenses incurred under the Plan on behalf
of the Fund and, in the case of Class B shares, opportunity costs, such as the
gross sales credit and an assumed interest charge thereon ("carrying charge").
In the Distributor's reporting of the distribution expenses to the Fund, in the
case of Class B shares, such assumed interest (computed at the "broker's call
rate") has been calculated on the gross credit as it is reduced by amounts
received by the Distributor under the Plan and any contingent deferred sales
charges received by the Distributor upon redemption of shares of the Fund. No
other interest charge is included as a distribution expense in the Distributor's
calculation of its distribution costs for this purpose. The broker's call rate
is the interest rate charged to securities brokers on loans secured by
exchange-listed securities.
The Fund is authorized to reimburse expenses incurred or to be incurred in
promoting the distribution of the Fund's Class A and Class C shares and in
servicing shareholder accounts. Reimbursement will be made through payments at
the end of each month. The amount of each monthly payment may in no event exceed
an amount equal to a payment at the annual rate of 0.25%, in the case of Class
A, and 0.75%, in the case of Class C, of the average net assets of the
respective Class during the month. No interest or other financing charges, if
any, incurred on any distribution expenses on behalf of Class A and
25
<PAGE>
Class C will be reimbursable under the Plan. With respect to Class A, in the
case of all expenses other than expenses representing the service fee, and, with
respect to Class C, in the case of all expenses other than expenses representing
a gross sales credit or a residual to Financial Advisors and other authorized
financial representatives, such amounts shall be determined at the beginning of
each calendar quarter by the Trustees, including, a majority of the Independent
Trustees. Expenses representing the service fee (for Class A) or a gross sales
credit or a residual to Financial Advisors and other authorized financial
representatives (for Class C) may be reimbursed without prior determination. In
the event that the Distributor proposes that monies shall be reimbursed for
other than such expenses, then in making quarterly determinations of the amounts
that may be reimbursed by the Fund, the Distributor will provide and the
Trustees will review a quarterly budget of projected distribution expenses to be
incurred on behalf of the Fund, together with a report explaining the purposes
and anticipated benefits of incurring such expenses. The Trustees will determine
which particular expenses, and the portions thereof, that may be borne by the
Fund, and in making such a determination shall consider the scope of the
Distributor's commitment to promoting the distribution of the Fund's Class A and
Class C shares.
Each Class paid 100% of the amounts accrued under the Plan with respect to
that Class for the fiscal year ended December 31, 1998 to the Distributor. The
Distributor and Dean Witter Reynolds estimate that they have spent, pursuant to
the Plan, $85,599,795 on behalf of Class B since the inception of the Plan. It
is estimated that this amount was spent in approximately the following ways: (i)
4.43% ($3,792,254)--advertising and promotional expenses; (ii) 0.33% ($278,382
)--printing of prospectuses for distribution to other than current shareholders;
and (iii) 95.24% ($81,529,159)--other expenses, including the gross sales credit
and the carrying charge, of which 7.51% ($6,119,779) represents carrying
charges, 37.83% ($30,842,436) represents commission credits to Dean Witter
Reynolds branch offices and other authorized financial representatives for
payments of commissions to Financial Advisors and other authorized financial
representatives, and 54.66% ($44,566,944) represents overhead and other branch
office distribution-related expenses. The amounts accrued by Class A and Class C
for distribution during the fiscal year ended December 31, 1998 were for
expenses which relate to compensation of sales personnel and associated overhead
expenses.
In the case of Class B shares, at any given time, the expenses of
distributing shares of the Fund may be more or less than the total of (i) the
payments made by the Fund pursuant to the Plan; and (ii) the proceeds of CDSCs
paid by investors upon redemption of shares. For example, if $1 million in
expenses in distributing Class B shares of the Fund had been incurred and
$750,000 had been received as described in (i) and (ii) above, the excess
expense would amount to $250,000. The Distributor has advised the Fund that in
the case of Class B shares the excess distribution expenses, including the
carrying charge designed to approximate the opportunity costs incurred by Dean
Witter Reynolds which arise from it having advanced monies without having
received the amount of any sales charges imposed at the time of sale of the
Fund's Class B shares, totaled ($230,396) as of December 31, 1998 (the end of
the Fund's fiscal year), which was equal to -0.03% of the net assets of Class B
on such date. Because there is no requirement under the Plan that the
Distributor be reimbursed for all distribution expenses with respect to Class B
shares or any requirement that the Plan be continued from year to year, this
excess amount does not constitute a liability of the Fund. Although there is no
legal obligation for the Fund to pay expenses incurred in excess of payments
made to the Distributor under the Plan and the proceeds of CDSCs paid by
investors upon redemption of shares, if for any reason the Plan is terminated,
the Trustees will consider at that time the manner in which to treat such
expenses. Any cumulative expenses incurred, but not yet recovered through
distribution fees or CDSCs, may or may not be recovered through future
distribution fees or CDSCs.
In the case of Class A and Class C shares, expenses incurred pursuant to the
Plan in any calendar year in excess of 0.25% or 0.75% of the average daily net
assets of Class A or Class C, respectively, will not be reimbursed by the Fund
through payments in any subsequent year, except that expenses representing a
gross sales commission credited to Morgan Stanley Dean Witter Financial Advisors
and other authorized financial representatives at the time of sale may be
reimbursed in the subsequent calendar year. The Distributor has advised the Fund
that unreimbursed expenses representing a gross sales commission credited to
Morgan Stanley Dean Witter Financial Advisors and other authorized financial
representatives at the time of sale totaled $20,536 in the case of Class C at
December 31, 1998 (the end of the calendar year), which amount was equal to
0.21% of the net assets of Class C on such
26
<PAGE>
date, and that there were no such expenses that may be reimbursed in the
subsequent year in the case of Class A on such date. No interest or other
financing charges will be incurred on any Class A or Class C distribution
expenses incurred by the Distributor under the Plan or on any unreimbursed
expenses due to the Distributor pursuant to the Plan.
No interested person of the Fund nor any Independent Trustee has any direct
financial interest in the operation of the Plan except to the extent that the
Distributor, the Investment Manager, Dean Witter Reynolds, MSDW Services Company
or certain of their employees may be deemed to have such an interest as a result
of benefits derived from the successful operation of the Plan or as a result of
receiving a portion of the amounts expended thereunder by the Fund.
On an annual basis, the Trustees, including a majority of the Independent
Trustees, consider whether the Plan should be continued. Prior to approving the
last continuation of the Plan, the Trustees requested and received from the
Distributor and reviewed all the information which they deemed necessary to
arrive at an informed determination. In making their determination to continue
the Plan, the Trustees considered: (1) the Fund's experience under the Plan and
whether such experience indicates that the Plan is operating as anticipated; (2)
the benefits the Fund had obtained, was obtaining and would be likely to obtain
under the Plan, including that: (a) the Plan is essential in order to give Fund
investors a choice of alternatives for payment of distribution and service
charges and to enable the Fund to continue to grow and avoid a pattern of net
redemptions which, in turn, are essential for effective investment management;
and (b) without the compensation to individual brokers and the reimbursement of
distribution and account maintenance expenses of Dean Witter Reynolds's branch
offices made possible by the 12b-1 fees, Dean Witter Reynolds could not
establish and maintain an effective system for distribution, servicing of Fund
shareholders and maintenance of shareholder accounts; and (3) what services had
been provided and were continuing to be provided under the Plan to the Fund and
its shareholders. Based upon their review, the Trustees, including each of the
Independent Trustees, determined that continuation of the Plan would be in the
best interest of the Fund and would have a reasonable likelihood of continuing
to benefit the Fund and its shareholders. In the Trustees' quarterly review of
the Plan, they will consider its continued appropriateness and the level of
compensation provided therein.
The Plan may not be amended to increase materially the amount to be spent
for the services described therein without approval by the shareholders of the
affected Class or Classes of the Fund, and all material amendments to the Plan
must also be approved by the Trustees in the manner described above. The Plan
may be terminated at any time, without payment of any penalty, by vote of a
majority of the Independent Trustees or by a vote of a majority of the
outstanding voting securities of the Fund (as defined in the Investment Company
Act) on not more than thirty days' written notice to any other party to the
Plan. So long as the Plan is in effect, the election and nomination of
Independent Trustees shall be committed to the discretion of the Independent
Trustees.
F. OTHER SERVICE PROVIDERS
(1) TRANSFER AGENT/DIVIDEND-PAYING AGENT
Morgan Stanley Dean Witter Trust FSB is the Transfer Agent for the Fund's
shares and the Dividend Disbursing Agent for payment of dividends and
distributions on Fund shares and Agent for shareholders under various investment
plans. The principal business address of the Transfer Agent is Harborside
Financial Center, Plaza Two, Jersey City, New Jersey 07311.
(2) CUSTODIAN AND INDEPENDENT ACCOUNTANTS
The Bank of New York, 90 Washington Street, New York, New York, 10286 is the
Custodian of the Fund's assets. Any of the Fund's cash balances with the
Custodian in excess of $100,000 are unprotected by federal deposit insurance.
These balances may, at times, be substantial.
PricewaterhouseCoopers LLP, 1177 Avenue of the Americas, New York, New York
10036 serves as the independent accountants of the Fund. The independent
accountants are responsible for auditing the annual financial statements of the
Fund.
27
<PAGE>
(3) AFFILIATED PERSONS
The Transfer Agent is an affiliate of the Investment Manager, and of the
Distributor. As Transfer Agent and Dividend Disbursing Agent, the Transfer
Agent's responsibilities include maintaining shareholder accounts, disbursing
cash dividends and reinvesting dividends, processing account registration
changes, handling purchase and redemption transactions, mailing prospectuses and
reports, mailing and tabulating proxies, processing share certificate
transactions, and maintaining shareholder records and lists. For these services,
the Transfer Agent receives a per shareholder account fee from the Fund and is
reimbursed for its out-of-pocket expenses in connection with such services.
VI. BROKERAGE ALLOCATION AND OTHER PRACTICES
- --------------------------------------------------------------------------------
A. BROKERAGE TRANSACTIONS
Subject to the general supervision of the Trustees, the Investment Manager
is responsible for decisions to buy and sell securities for the Fund, the
selection of brokers and dealers to effect the transactions, and the negotiation
of brokerage commissions, if any. In the over-the-counter market, securities are
generally traded on a "net" basis with dealers acting as principal for their own
accounts without a stated commission, although the price of the security usually
includes a profit to the dealer. The Fund also expects that securities will be
purchased at times in underwritten offerings where the price includes a fixed
amount of compensation, generally referred to as the underwriter's concession or
discount. Options and futures transactions will usually be effected through a
broker and a commission will be charged. On occasion, the Fund may also purchase
certain money market instruments directly from an issuer, in which case no
commissions or discounts are paid.
For the fiscal years ended December 31, 1996, 1997 and 1998, the Fund did
not pay any brokerage commissions.
B. COMMISSIONS
Pursuant to an order of the SEC, the Fund may effect principal transactions
in certain money market instruments with Dean Witter Reynolds. The Fund will
limit its transactions with Dean Witter Reynolds to U.S. Government and
government agency securities, bank money instruments (i.e., certificates of
deposit and bankers' acceptances) and commercial paper. The transactions will be
effected with Dean Witter Reynolds only when the price available from Dean
Witter Reynolds is better than that available from other dealers.
During the fiscal years ended December 31, 1996, 1997 and 1998, the Fund did
not effect any principal transactions with Dean Witter Reynolds.
Consistent with the policy described above, brokerage transactions in
securities listed on exchanges or admitted to unlisted trading privileges may be
effected through Dean Witter Reynolds, Morgan Stanley & Co. and other affiliated
brokers and dealers. In order for an affiliated broker or dealer to effect any
portfolio transactions on an exchange for the Fund, the commissions, fees or
other remuneration received by the affiliated broker or dealer must be
reasonable and fair compared to the commissions, fees or other remuneration paid
to other brokers in connection with comparable transactions involving similar
securities being purchased or sold on an exchange during a comparable period of
time. This standard would allow the affiliated broker or dealer to receive no
more than the remuneration which would be expected to be received by an
unaffiliated broker in a commensurate arm's-length transaction. Furthermore, the
Trustees, including the Independent Trustees, have adopted procedures which are
reasonably designed to provide that any commissions, fees or other remuneration
paid to an affiliated broker or dealer are consistent with the foregoing
standard. The Fund does not reduce the management fee it pays to the Investment
Manager by any amount of the brokerage commissions it may pay to an affiliated
broker or dealer.
C. BROKERAGE SELECTION
The policy of the Fund regarding purchases and sales of securities for its
portfolio is that primary consideration will be given to obtaining the most
favorable prices and efficient executions of transactions. In seeking to
implement the Fund's policies, the Investment Manager effects transactions with
those brokers and dealers who the Investment Manager believes provide the most
favorable prices and
28
<PAGE>
are capable of providing efficient executions. If the Investment Manager
believes the prices and executions are obtainable from more than one broker or
dealer, it may give consideration to placing portfolio transactions with those
brokers and dealers who also furnish research and other services to the Fund or
the Investment Manager. The services may include, but are not limited to, any
one or more of the following: information as to the availability of securities
for purchase or sale; statistical or factual information or opinions pertaining
to investment; wire services; and appraisals or evaluations of portfolio
securities. The information and services received by the Investment Manager from
brokers and dealers may be of benefit to the Investment Manager in the
management of accounts of some of its other clients and may not in all cases
benefit the Fund directly.
The Investment Manager currently serves as investment manager to a number of
clients, including other investment companies, and may in the future act as
investment manager or advisor to others. It is the practice of the Investment
Manager to cause purchase and sale transactions to be allocated among the Fund
and others whose assets it manages in such manner as it deems equitable. In
making such allocations among the Fund and other client accounts, various
factors may be considered, including the respective investment objectives, the
relative size of portfolio holdings of the same or comparable securities, the
availability of cash for investment, the size of investment commitments
generally held and the opinions of the persons responsible for managing the
portfolios of the Fund and other client accounts. In the case of certain initial
and secondary public offerings, the Investment Manager utilizes a pro rata
allocation process based on the size of the Morgan Stanley Dean Witter Funds
involved and the number of shares available from the public offering.
D. DIRECTED BROKERAGE
During the fiscal year ended December 31, 1998, the Fund did not pay any
brokerage commissions in connection with transactions to brokers because of
research services provided.
E. REGULAR BROKER-DEALERS
During the fiscal year ended December 31, 1998, the Fund did not purchase
securities issued by brokers or dealers that were among the ten brokers or the
ten dealers which executed transactions for or with the Fund in the largest
dollar amounts during the year. At December 31, 1998, the Fund did not purchase
securities issued by any of such issuers.
VII. CAPITAL STOCK AND OTHER SECURITIES
- --------------------------------------------------------------------------------
The shareholders of the Fund are entitled to a full vote for each full share
of beneficial interest held. The Fund is authorized to issue an unlimited number
of shares of beneficial interest. All shares of beneficial interest of the Fund
are of $0.01 par value and are equal as to earnings, assets and voting
privileges except that each Class will have exclusive voting privileges with
respect to matters relating to distribution expenses borne solely by such Class
or any other matter in which the interests of one Class differ from the
interests of any other Class. In addition, Class B shareholders will have the
right to vote on any proposed material increase in Class A's expenses, if such
proposal is submitted separately to Class A shareholders. Also, Class A, Class B
and Class C bear expenses related to the distribution of their respective
shares.
The Fund's Declaration of Trust permits the Trustees to authorize the
creation of additional series of shares (the proceeds of which would be invested
in separate, independently managed portfolios) and additional Classes of shares
within any series. The Trustees have not presently authorized any such
additional series or Classes of shares other than as set forth in the
PROSPECTUS.
The Fund is not required to hold annual meetings of shareholders and in
ordinary circumstances the Fund does not intend to hold such meetings. The
Trustees may call special meetings of shareholders for action by shareholder
vote as may be required by the Investment Company Act or the Declaration of
Trust. Under certain circumstances, the Trustees may be removed by action of the
Trustees or by the shareholders.
Under Massachusetts law, shareholders of a business trust may, under certain
limited circumstances, be held personally liable as partners for the obligations
of the Fund. However, the Declaration of Trust contains an express disclaimer of
shareholder liability for acts or obligations of the Fund, requires that notice
of such Fund obligations include such disclaimer, and provides for
indemnification out of the
29
<PAGE>
Fund's property for any shareholder held personally liable for the obligations
of the Fund. 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. Given the above limitations on
shareholder personal liability, and the nature of the Fund's assets and
operations, the possibility of the Fund being unable to meet its obligations is
remote and thus, in the opinion of Massachusetts counsel to the Fund, the risk
to Fund shareholders of personal liability is remote.
All of the Trustees have been elected by the shareholders of the Fund, most
recently at a Special Meeting of Shareholders held on May 21, 1997. The Trustees
themselves have the power to alter the number and the terms of office of the
Trustees (as provided for in the Declaration of Trust), and they may at any time
lengthen or shorten their own terms or make their terms of unlimited duration
and appoint their own successors, provided that always at least a majority of
the Trustees has been elected by the shareholders of the Fund.
VIII. PURCHASE, REDEMPTION AND PRICING OF SHARES
- --------------------------------------------------------------------------------
A. PURCHASE OF SHARES
Information concerning how Fund shares are offered to the public (and how
they are redeemed and exchanged) is provided in the Fund's PROSPECTUS.
TRANSFER AGENT AS AGENT. With respect to the redemption or repurchase of
Fund shares, the application of proceeds to the purchase of new shares in the
Fund or any other Morgan Stanley Dean Witter Funds and the general
administration of the exchange privilege, the Transfer Agent acts as agent for
the Distributor and for the shareholder's authorized broker-dealer, if any, in
the performance of such functions. With respect to exchanges, redemptions or
repurchases, the Transfer Agent shall be liable for its own negligence and not
for the default or negligence of its correspondents or for losses in transit.
The Fund shall not be liable for any default or negligence of the Transfer
Agent, the Distributor or any authorized broker-dealer.
The Distributor and any authorized broker-dealer have appointed the Transfer
Agent to act as their agent in connection with the application of proceeds of
any redemption of Fund shares to the purchase of shares of any other Morgan
Stanley Dean Witter Fund and the general administration of the exchange
privilege. No commission or discounts will be paid to the Distributor or any
authorized broker-dealer for any transaction pursuant to the exchange privilege.
TRANSFERS OF SHARES. In the event a shareholder requests a transfer of Fund
shares to a new registration, the shares will be transferred without sales
charge at the time of transfer. With regard to the status of shares which are
either subject to the CDSC or free of such charge (and with regard to the length
of time shares subject to the charge have been held), any transfer involving
less than all of the shares in an account will be made on a pro rata basis (that
is, by transferring shares in the same proportion that the transferred shares
bear to the total shares in the account immediately prior to the transfer). The
transferred shares will continue to be subject to any applicable CDSC as if they
had not been so transferred.
B. OFFERING PRICE
The Fund's Class B, Class C and Class D shares are offered at net asset
value per share and the Class A shares are offered at net asset value per share
plus any applicable FSC which is distributed among the Fund's Distributor, Dean
Witter Reynolds and other authorized dealers as described in Section "V.
Investment Management and Other Services--E Rule 12b-1 Plan."
The price of the Fund, called "net asset value," is based on the value of
the Fund's portfolio securities.
Portfolio securities (other than short-term debt securities and futures and
options) are valued for the Fund by an outside independent pricing service
approved by the Trustees. The pricing service has informed the Fund that in
valuing the portfolio securities for the Fund it uses both a computerized grid
matrix of tax-exempt securities and evaluations by its staff, in each case based
on information concerning market transactions and quotations from dealers which
reflect the bid side of the market each day. The portfolio securities for the
Fund are thus valued by reference to a combination of transactions and
30
<PAGE>
quotations for the same or other securities believed to be comparable in
quality, coupon, maturity, type of issue, call provisions, trading
characteristics and other features deemed to be relevant. The Trustees believe
that timely and reliable market quotations are generally not readily available
to the Fund for purposes of valuing tax-exempt securities and that the
valuations supplied by the pricing service, using the procedures outlined above
and subject to periodic review, are more likely to approximate the fair value of
such securities. The Investment Manager will periodically review and evaluate
the procedures, methods and quality of services provided by the pricing service
then being used by the Fund and may, from time to time, recommend to the
Trustees the use of other pricing services or discontinuance of the use of any
pricing service in whole or part. The Trustees may determine to approve such
recommendation or take other provisions for pricing of the portfolio securities
for the Fund.
Short-term taxable debt securities with remaining maturities of 60 days or
less at time of purchase are valued at amortized cost, unless the Trustees
determine such does not reflect the securities' market value, in which case
these securities will be valued at their fair value as determined by the
Trustees. Other taxable short-term debt securities with maturities of more than
60 days will be valued on a mark to market basis until such time as they reach a
maturity of 60 days, whereupon they will be valued at amortized cost using their
value on the 61st day unless the Trustees determine such does not reflect the
securities' fair value, in which case these securities will be valued at their
fair market value as determined by the Trustees. Listed options on debt
securities are valued at the latest sale price on the exchange on which they are
listed unless no sales of such options have taken place that day, in which case,
they will be valued at the mean between their closing bid and asked prices.
Unlisted options on debt securities are valued at the mean between their latest
bid and asked price. Futures are valued at the latest sale price on the
commodities exchange on which they trade unless the Trustees determines that
such price does not reflect their fair value, in which case they will be valued
at their fair market value as determined by the Trustees. All other securities
and other assets are valued at their fair value as determined in good faith
under procedures established by and under the supervision of the Trustees.
IX. TAXATION OF THE FUND AND SHAREHOLDERS
- --------------------------------------------------------------------------------
The Fund generally will make three basic types of distributions: tax exempt
dividends, ordinary dividends and long-term capital gain distributions. These
types of distributions are reported differently on a shareholder's income tax
return and they are also subject to different rates of tax. The tax treatment of
the investment activities of the Fund will affect the amount and timing and
character of the distributions made by the Fund. Shareholders are urged to
consult their own tax professionals regarding specific questions as to federal,
state or local taxes.
INVESTMENT COMPANY TAXATION. The Fund intends to remain qualified as a
regulated investment company under Subchapter M of the Internal Revenue Code of
1986. As such, the Fund will not be subject to federal income tax on its net
investment income and capital gains, if any, to the extent that it distributes
such income and capital gains to its shareholders.
All or a portion of any gain from tax-exempt obligations purchased at a
market discount may be treated as ordinary income rather than capital gain.
From time to time, proposals have been introduced before Congress for the
purpose of restricting or eliminating the federal income tax exemption for
interest on municipal securities. Similar proposals may be introduced in the
future. If such a proposal were enacted, the availability of municipal
securities for investment by the Fund could be affected. In that event, the Fund
would re-evaluate its investment objective and policies.
TAXATION OF DIVIDENDS AND DISTRIBUTIONS. The Fund intends to qualify to pay
"exempt-interest dividends" to its shareholders by maintaining, as of the close
of each of its taxable years, at least 50% of the value of its assets in
tax-exempt securities. An obligation shall be considered a tax-exempt security
only if, in the opinion of bond counsel, the interest payable thereon is exempt
from federal and California income tax. An exempt-interest dividend is that part
of the dividend distributions made by the Fund which consists of interest
received by the Fund on tax-exempt securities upon which the shareholder incurs
no federal income taxes. Exempt-interest dividends are included, however, in
determining what portion, if any, of a person's Social Security benefits are
subject to federal income tax.
31
<PAGE>
The Fund intends to invest a portion of its assets in certain "private
activity bonds". As a result, a portion of the exempt-interest dividends paid by
the Fund will be an item of tax preference to shareholders subject to the
alternative minimum tax. Certain corporations which are subject to the
alternative minimum tax may also have to include exempt-interest dividends in
calculating their alternative minimum taxable income in situations where the
"adjusted current earnings" of the corporation exceeds its alternative minimum
taxable income.
Shareholders will be subject to federal income tax on dividends paid from
interest income derived from taxable securities and on distributions of net
short-term capital gains. Such dividends and distributions are taxable to the
shareholder as ordinary dividend income regardless of whether the shareholder
receives such distributions in additional shares or in cash. Distributions of
long-term capital gains, if any, are taxable as long-term capital gains,
regardless of how long the shareholder has held the Fund shares and regardless
of whether the distribution is received in additional shares or in cash. Since
the income of the Fund is expected to be derived entirely from interest rather
than dividends, it is anticipated that no portion of such dividend distributions
will be eligible for the federal dividends received deduction available to
corporations.
Shareholders are generally taxed on any ordinary dividend or capital gain
distributions from the Fund in the year they are actually distributed. However,
if any such dividends or distributions are declared in October, November or
December and paid in January then such amounts will be treated for tax purposes
as received by the shareholders on December 31, to shareholders of record of
such month.
Shareholders who are not citizens or residents of the United States and
certain foreign entities may be subject to withholding of United States tax on
distributions made by the Fund of any taxable interest income and short term
capital gains.
After the end of each calendar year, shareholders will be sent full
information on their dividends and capital gain distributions for tax purposes,
including the portion taxable as ordinary income, the portion taxable as
long-term capital gains and the percentage of any distributions which constitute
an item of tax preference for purposes of the alternative minimum tax.
PURCHASES AND REDEMPTIONS AND EXCHANGES OF FUND SHARES. Any dividend or
capital gains distribution received by a shareholder from the Fund will have the
effect of reducing the net asset value of the shareholder's stock in the Fund by
the exact amount of the dividend or capital gains distribution. Furthermore,
capital gains distributions and some portion of the dividends may be subject to
federal income taxes. If the net asset value of the shares should be reduced
below a shareholder's cost as a result of the payment of dividends or the
distribution of realized long-term capital gains, such payment or distribution
would be in part a return of the shareholder's investment but nonetheless would
be taxable to the shareholder. Therefore, an investor should consider the tax
implications of purchasing shares of the Fund immediately prior to a
distribution record date.
In general, a sale of shares results in capital gain or loss, and for
individual shareholders, is taxable at a federal rate dependent upon the length
of time the shares were held. A redemption of a shareholder's Fund shares is
normally treated as a sale for tax purposes. Shares of the Fund held for a
period of one year or less will, for tax purposes, generally result in
short-term gains or losses and those held for more than one year generally
result in long-term gain or loss. Any loss realized by shareholders upon a
redemption of shares within six months of the date of their purchase will be
treated as a long-term capital loss to the extent of any distributions of net
long-term capital gains with respect to such shares during the six-month period.
Gain or loss on the sale or redemption of shares in the Fund is measured by
the difference between the amount received and the tax basis of the shares.
Shareholders should keep records of investments made (including shares acquired
through reinvestment of dividends and distributions) so they can compute the tax
basis of their shares. Under certain circumstances a shareholder may compute and
use an average cost basis in determining the gain or loss on the sale or
redemption of shares.
32
<PAGE>
Exchanges of shares in the Fund for shares of other Morgan Stanley Dean
Witter Funds, are also subject to similar tax treatment. Such an exchange is
treated for tax purposes as a sale of the original shares in the Fund, followed
by the purchase of shares in the Fund.
If a shareholder realizes a loss on the redemption or exchange of a shares
in the Fund and reinvests in shares of the Fund within 30 days before or after
the redemption or exchange, the transactions may be subject to the "wash sale"
rules, resulting in a postponement of the recognition of such loss for tax
purposes.
Interest on indebtedness incurred by shareholders to purchase or carry
shares of the Fund is not deductible. Furthermore, entities or persons who are
"substantial users" (or related persons) of facilities financed by industrial
development bonds should consult their tax advisers before purchasing shares of
the Fund. "Substantial user" is defined generally by Income Tax Regulation
1.103-11(b) as including a "non-exempt person" who regularly uses in a trade or
business a part of a facility financed from the proceeds of industrial
development bonds.
THE STATE OF CALIFORNIA--SPECIAL TAX CONSIDERATIONS. In any year in which
the Fund qualifies as a regulated investment company under the Internal Revenue
Code as in effect on January 1, 1998, and is exempt from federal income tax, (i)
the Fund will also be exempt from the California corporate income and franchise
taxes to the extent it distributes its income and (ii), provided 50% or more of
the value of the total assets of the Fund at the close of each quarter of its
taxable year consists of obligations the interest on which (when held by an
individual) is exempt from personal income taxation under California law, the
Fund will be qualified under California law to pay "exempt-interest" dividends
which will be exempt from the California personal income tax.
The portion of dividends constituting exempt-interest dividends is that
portion derived from interest on obligations which pay interest excludable from
California personal income under California law. The total amount of California
exempt-interest dividends paid by the Fund to all of its shareholders with
respect to any taxable year cannot exceed the amount of interest received by the
Fund during such year on such obligations less any expenses and expenditures
(including dividends paid to corporate shareholders) deemed to have been paid
from such interest. Any dividends paid to corporate shareholders subject to the
California franchise tax will be taxed as ordinary dividends to such
shareholders.
Individual shareholders of the Fund who reside in California will not be
subject to California personal income tax on distributions received from the
Fund to the extent such distributions are attributable to interest received by
the Fund during its taxable year on obligations, the interest on which (when
held by an individual) is exempt from taxation under California law.
Because, unlike Federal law, California law does not impose personal income
tax an an individual's Social Security benefits, the receipt of California
exempt-interest dividends will have no effect on an individual's California
personal income tax.
Individual shareholders will normally be subject to federal and California
personal income tax on dividends paid from interest income derived from taxable
securities and distributions of net capital gains. In addition, distributions
other than exempt-interest dividends to such shareholders are includable in
income subject to the California alternative minimum tax. For federal income tax
and California personal income tax purposes, distributions of long-term capital
gains, if any, are taxable to shareholders as long-term capital gains,
regardless of how long a shareholder has held shares of the Fund and regardless
of whether the distribution is received in additional shares or in cash. The
maximum federal capital gains rate for individuals is 20% with respect to
capital assets held more than 12 months. The maximum capital gains rate for
corporate shareholders is the same as the maximum tax rate for ordinary income.
In addition, unlike federal law, the shareholders of the Fund will not be
subject to tax, or receive a credit for tax paid by the Fund, on undistributed
capital gains, if any.
Interest on indebtedness incurred by shareholders or related parties to
purchase or carry shares of an investment company paying exempt-interest
dividends, such as the Fund, generally will not be deductible by the investor
for federal or state personal income tax purposes. In addition, as a result of
33
<PAGE>
California's incorporation of certain provisions of the Code, a loss realized by
a shareholder upon the sale of shares held for six months or less may be
disallowed to the extent of any exempt-interest dividends received with respect
to such shares. Moreover, any loss realized upon the redemption of shares within
six months from the date of purchase of such shares and following receipt of a
long-term capital gains distribution will be treated as long-term capital loss
to the extent of such long-term capital gains distribution. Finally, any loss
realized upon the redemption of shares within 30 days before or after the
acquisition of other shares of the Fund may be disallowed under the "wash sale"
rules.
Distributions from investment income and long-term and short-term capital
gains will not be excludable from taxable income in determining the California
corporate franchise tax for corporate shareholders. Such distributions may also
be includable in income subject to the alternative minimum tax. In addition,
distributions from investment income and long-term and short-term capital gains
may be subject to state taxes in states other than California, and to local
taxes.
X. UNDERWRITERS
- --------------------------------------------------------------------------------
The Fund's shares are offered to the public on a continuous basis. The
Distributor, as the principal underwriter of the shares, has certain obligations
under the Distribution Agreement concerning the distribution of the shares.
These obligations and the compensation the Distributor receives are described
above in the sections titled "Principal Underwriter" and "Rule 12b-1 Plans."
XI. CALCULATION OF PERFORMANCE DATA
- --------------------------------------------------------------------------------
From time to time, the Fund may quote its "yield" and/or "total return" in
advertisements and sales literature. These figures are computed separately for
Class A, Class B, Class C and Class D shares. Yield is calculated for any 30-day
period as follows: the amount of interest income for each security in the Fund's
portfolio is determined in accordance with regulatory requirements; the total
for the entire portfolio constitutes the Fund's gross income for the period.
Expenses accrued during the period are subtracted to arrive at "net investment
income" of each Class. The resulting amount is divided by the product of the
maximum offering price per share on the last day of the period multiplied by the
average number of shares of the applicable Class outstanding during the period
that were entitled to dividends. This amount is added to 1 and raised to the
sixth power. 1 is then subtracted from the result and the difference is
multiplied by 2 to arrive at the annualized yield. The yields for the 30-day
period ended December 31, 1998, calculated pursuant to the formula described
above, were 3.77%, 3.43%, 3.43% and 4.20% for Class A, Class B, Class C and
Class D, respectively.
These figures are computed separately for Class A, Class B, Class C and
Class D shares. The Fund's "average annual total return" represents an
annualization of the Fund's total return over a particular period and is
computed by finding the annual percentage rate which will result in the ending
redeemable value of a hypothetical $1,000 investment made at the beginning of a
one, five or ten year period, or for the period from the date of commencement of
operations, if shorter than any of the foregoing. The ending redeemable value is
reduced by any contingent deferred sales charge ("CDSC") at the end of the one,
five, ten year or other period. For the purpose of this calculation, it is
assumed that all dividends and distributions are reinvested. The formula for
computing the average annual total return involves a percentage obtained by
dividing the ending redeemable value by the amount of the initial investment
(which in the case of Class A shares is reduced by the Class A initial sales
charge), taking a root of the quotient (where the root is equivalent to the
number of years in the period) and subtracting 1 from the result. The average
annual total returns for Class B for the one year, five year and ten year
periods ended December 31, 1998 were 0.67%, -4.51% and 6.81%, respectively. The
average annual total returns of Class A for the fiscal year ended December 31,
1998 and for the period July 28, 1997 (inception of the Class) through December
31, 1998 were 1.02% and 2.69%, respectively. The average annual total returns of
Class C for the fiscal year ended December 31, 1998 and for the period July 28,
1997 (inception of the Class) through December 31, 1998 were 4.23% and 5.66%,
respectively. The average annual total returns of Class D for the fiscal year
ended December 31, 1998 and for the period July 28, 1997 (inception of the
Class) through December 31, 1998 were 5.77% and 6.32%, respectively.
34
<PAGE>
In addition, the Fund may advertise its total return for each Class over
different periods of time by means of aggregate, average, year-by-year or other
types of total return figures. These calculations may or may not reflect the
imposition of the maximum front-end sales charge for Class A or the deduction of
the CDSC for each of Class B and Class C which, if reflected, would reduce the
performance quoted. For example, the average annual total return of the Fund may
be calculated in the manner described above, but without deduction for any
applicable sales charge. Based on this calculation, the average annual total
returns of Class B for the one year, five year and ten year periods ended
December 31, 1998, were 5.63%, 4.83% and 6.81%, respectively. The average annual
total returns of Class A for the fiscal year ended December 31, 1998 and for the
period July 28, 1997 through December 31, 1998 were 5.50% and 5.87%,
respectively. The average annual total returns of Class C for the fiscal year
ended December 31, 1998 and for the period July 28, 1997 through December 31,
1998 were 5.22% and 5.66%, respectively. The average annual total returns of
Class D for the fiscal year ended December 31, 1998 and for the period July 28,
1997 through December 31, 1998 were 5.77% and 6.32%, respectively.
In addition, the Fund may compute its aggregate total return for each Class
for specified periods by determining the aggregate percentage rate which will
result in the ending value of a hypothetical $1,000 investment made at the
beginning of the period. For the purpose of this calculation, it is assumed that
all dividends and distributions are reinvested. The formula for computing
aggregate total return involves a percentage obtained by dividing the ending
value (without reduction for any sales charge) by the initial $1,000 investment
and subtracting 1 from the result. Based on the foregoing calculation, the total
returns for Class B for the one year, five year and ten year periods ended
December 31, 1998, were 5.63%, 26.61% and 93.24%, respectively. The total
returns of Class A for the fiscal year ended December 31, 1998 and for the
period July 28, 1997 through December 31, 1998 were 5.50% and 8.48%,
respectively. The total returns of Class C for the fiscal year ended December
31, 1998 and for the period July 28, 1997 through December 31, 1998 were 5.22%
and 8.17%, respectively. The total returns of Class D for the fiscal year ended
December 31, 1998 and for the period July 28, 1997 through December 31, 1998
were 5.77% and 9.13%, respectively.
The Fund may also advertise the growth of hypothetical investments of
$10,000, $50,000 and $100,000 in each Class of shares of the Fund by adding 1 to
the Fund's aggregate total return to date (expressed as a decimal and without
taking into account the effect of any applicable CDSC) and multiplying by
$9,575, $48,250 and $97,250 in the case of Class A (investments of $10,000,
$50,000 and $100,000 adjusted for the initial sales charge) or by $10,000,
$50,000 and $100,000 in the case of each of Class B, Class C and Class D, as the
case may be. Investments of $10,000, $50,000 and $100,000 in each Class at
inception of the Class would have grown to the following amounts at December 31,
1998:
<TABLE>
<CAPTION>
INVESTMENT AT INCEPTION OF:
INCEPTION -----------------------------------
CLASS DATE: $10,000 $50,000 $100,000
- --------------------------------------------------------------- ---------- --------- ----------- -----------
<S> <C> <C> <C> <C>
Class A........................................................ 7/28/97 $ 10,387 $ 52,342 $ 105,497
Class B........................................................ 7/11/84 31,567 157,835 315,670
Class C........................................................ 7/28/97 10,817 54,085 108,170
Class D........................................................ 7/28/97 10,913 54,565 109,130
</TABLE>
The Fund from time to time may also advertise its performance relative to
certain performance rankings and indexes compiled by independent organizations.
XII. FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
EXPERTS. The financial statements of the Fund for the fiscal year ended
December 31, 1998 included in this STATEMENT OF ADDITIONAL INFORMATION and
incorporated by reference in the PROSPECTUS are included herein in reliance on
the report of PricewaterhouseCoopers LLP, independent accountants, given on the
authority of said firm as experts in auditing and accounting.
* * * * *
35
<PAGE>
This STATEMENT OF ADDITIONAL INFORMATION and the PROSPECTUS do not contain
all of the information set forth in the REGISTRATION STATEMENT the Fund has
filed with the SEC. The complete REGISTRATION STATEMENT may be obtained from the
SEC.
The Fund generally intends to distribute sufficient income and gains so that
the Fund will not pay corporate income tax on its earnings. The Fund also
generally intends to distribute to its shareholders in each calendar year a
sufficient amount of ordinary income and capital gains to avoid the imposition
of a 4% excise tax. However, the Fund may instead determine to retain all or
part of any ordinary income or capital gains in any year for reinvestment. In
such event, the Fund will pay federal income tax (and possibly excise tax) on
such retained gains.
Gains or losses on sales of securities by the Fund will be long-term capital
gains or losses if the securities have a tax holding period of more than one
year. Gains or losses on the sale of securities with a tax holding period of one
year or less will be short-term gains or losses.
In computing net investment income, the Fund will amortize any premiums and
original issue discounts on securities owned, if applicable. Capital gains or
losses realized upon sale or maturity of such securities will be based on their
amortized cost.
36
<PAGE>
MORGAN STANLEY DEAN WITTER CALIFORNIA TAX-FREE INCOME FUND
PORTFOLIO OF INVESTMENTS DECEMBER 31, 1998
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- --------------------------------------------------------------------------------------------------------------------------------
<C> <S> <C> <C> <C>
CALIFORNIA TAX-EXEMPT MUNICIPAL BONDS (96.5%)
GENERAL OBLIGATION (8.6%)
California,
$ 5,000 Ser 1990..................................................................... 7.00% 08/01/07 $ 6,007,150
5,000 Ser 1990..................................................................... 7.00 08/01/08 6,085,250
2,000 Ser AT....................................................................... 9.50 02/01/10 2,892,300
2,400 Veterans Ser BH (AMT) (FSA).................................................. 5.40 12/01/16 2,463,648
10,000 Various Purpose Dtd 04/01/93 (FSA)........................................... 5.50 04/01/19 10,395,200
13,000 Ser 1996 (AMBAC)............................................................. 5.25 06/01/21 13,280,280
3,000 Veterans Ser BD, BE & BF (AMT) (AMBAC)....................................... 6.375 02/01/27 3,036,150
10,000 Refg Dtd 10/01/98 (MBIA)..................................................... 4.50 10/01/28 9,200,400
10,000 Los Angeles Unified School District, 1997 Ser B (FGIC)......................... 5.00 07/01/23 9,930,200
Santa Margarita/Dana Point Authority,
3,000 Impr Dists #2, 2A, 3 & 4 1997 Ser A (AMBAC).................................. 5.125 08/01/18 3,024,030
4,000 Impr Dists #3, 3A, 4 & 4A 1994 Ser B Refg (MBIA)............................. 5.75 08/01/20 4,246,800
8,500 Puerto Rico Public Improvement Ser 1999........................................ 4.75 07/01/23 8,086,560
------------
- ---------
78,647,968
75,900
------------
- ---------
EDUCATIONAL FACILITIES REVENUE (3.8%)
California Educational Facilities Authority,
6,000 University of San Diego Ser 1998 (AMBAC)..................................... 5.00 10/01/22 5,958,300
2,000 University of Southern California 1997 Ser A................................. 5.70 10/01/15 2,188,880
4,000 University of Southern California 1997 Ser C................................. 5.125 10/01/28 4,017,760
4,000 California Public Works Board, University of California 1997 Ser C (AMBAC)..... 5.125 09/01/22 4,020,960
California Statewide Communities Development Authority,
3,400 Gemological Institute of America COPs (Connie Lee)........................... 6.00 05/01/20 3,693,964
4,100 Gemological Institute of America COPs (Connie Lee)........................... 6.00 05/01/25 4,478,143
10,000 University of California, Multiple Purpose Refg Ser 1993 C (AMBAC)............. 5.125 09/01/18 10,123,700
------------
- ---------
34,481,707
33,500
------------
- ---------
ELECTRIC REVENUE (9.1%)
13,000 Los Angeles Department of Water & Power, Second Issue of 1993
(Secondary AMBAC)............................................................ 5.40 11/15/13 13,784,420
Northern California Power Agency,
5,000 Hydro #1 1993 Refg Ser A (MBIA).............................................. 5.50 07/01/16 5,211,850
5,000 Hydro #1 Refg 1998 Ser A (MBIA).............................................. 5.00 07/01/28 4,961,850
Sacramento Municipal Utility District,
5,700 Refg 1994 Ser H (MBIA)....................................................... 5.75 01/01/11 6,241,500
26,000 Refg 1992 Ser A (FGIC)....................................................... 6.30 08/15/18 28,386,280
Southern California Public Power Authority,
7,000 Mead-Adelanto 1994 Ser A (AMBAC)............................................. 5.15 07/01/15 7,342,160
1,750 Transmission Refg Ser 1988 (FGIC)............................................ 0.00 07/01/06 1,281,298
5,000 Turlock Irrigation District, Refg 1998 Ser A (MBIA)............................ 5.00 01/01/26 4,963,350
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS
37
<PAGE>
MORGAN STANLEY DEAN WITTER CALIFORNIA TAX-FREE INCOME FUND
PORTFOLIO OF INVESTMENTS DECEMBER 31, 1998, CONTINUED
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- --------------------------------------------------------------------------------------------------------------------------------
<C> <S> <C> <C> <C>
Puerto Rico Electric Power Authority,
$ 9,000 Power Ser O.................................................................. 5.00% 07/01/12 $ 9,017,370
2,000 Power Ser X.................................................................. 5.50 07/01/25 2,059,380
------------
- ---------
83,249,458
79,450
------------
- ---------
HOSPITAL REVENUE (5.7%)
10,000 Antelope Valley Healthcare District, Refg Ser 1997 A (FSA)..................... 5.20 01/01/20 10,176,100
California Health Facilities Financing Authority,
4,000 Little Company of Mary Hospital Ser 1998 A (AMBAC)........................... 4.50 10/01/28 3,680,160
5,000 Stanford Health Care 1998 Ser A (FSA)........................................ 5.00 11/15/28 4,946,150
3,500 Sutter/CHS Ser 1996 A (MBIA)................................................. 5.875 08/15/16 3,815,490
Duarte,
3,000 City of Hope National Medical Center Ser 1993 COPs........................... 5.50 04/01/01 3,109,440
4,000 City of Hope National Medical Center Ser 1993 COPs........................... 6.25 04/01/23 4,227,880
7,500 Madera County, Valley Children's Hospital Ser 1995 COPs (MBIA)................. 6.50 03/15/15 9,016,800
Rancho Mirage Joint Powers Financing Authority,
3,000 Eisenhower Medical Center Ser 1997 A COPs (MBIA)............................. 5.25 07/01/12 3,164,790
4,000 Eisenhower Medical Center Ser 1997 A COPs (MBIA)............................. 5.25 07/01/17 4,112,200
5,000 University of California, UCLA Medical Center Refg Ser 1994 (MBIA)............. 5.50 12/01/14 5,345,200
------------
- ---------
51,594,210
49,000
------------
- ---------
INDUSTRIAL DEVELOPMENT/POLLUTION CONTROL REVENUE (2.9%)
California Pollution Control Financing Authority,
5,000 Atlantic Richfield Co Ser 1996 A............................................. 5.00 04/01/08 5,297,750
3,000 San Diego Gas and Electric Co 1996 Ser A..................................... 5.90 06/01/14 3,369,030
10,000 Southern California Edison Co 1992 Ser B (AMT)............................... 6.40 12/01/24 10,934,400
5,000 Waste Management Inc 1991 Ser A (AMT)........................................ 7.15 02/01/11 5,353,500
1,400 Intermodal Container Transfer Facility Joint Powers Authority, Southern Pacific
Transportation Co 1989 Ser A................................................. 7.70 11/01/14 1,469,566
------------
- ---------
26,424,246
24,400
------------
- ---------
MORTGAGE REVENUE - SINGLE FAMILY (5.2%)
California Housing Finance Agency,
9,000 Home 1995 Ser J (AMBAC)...................................................... 6.00 08/01/17 9,595,619
4,210 Home 1989 Ser A.............................................................. 7.75 08/01/17 4,348,130
6,450 Home 1995 Ser M (AMT) (MBIA)................................................. 6.15 08/01/27 6,869,573
8,215 Home 1995 Ser K (AMT) (AMBAC)................................................ 6.25 08/01/27 8,782,246
3,805 Home 1991 Ser G (AMT)........................................................ 7.05 08/01/27 4,015,835
7,000 Purchase 1995 Ser B-2 (AMT).................................................. 6.30 08/01/24 7,446,040
California Rural Home Financing Authority,
2,095 1997 Ser D-CL 5 (AMT)........................................................ 6.70 05/01/29 2,402,169
2,000 GNMA-Backed 1998 Ser A (AMT)................................................. 5.75 12/01/29 2,188,360
Puerto Rico Housing Finance Corporation,
625 Portfolio One GNMA-Backed Ser B.............................................. 7.65 10/15/22 659,356
665 Portfolio One GNMA-Backed Ser C.............................................. 6.85 10/15/23 708,970
------------
- ---------
47,016,298
44,065
------------
- ---------
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS
38
<PAGE>
MORGAN STANLEY DEAN WITTER CALIFORNIA TAX-FREE INCOME FUND
PORTFOLIO OF INVESTMENTS DECEMBER 31, 1998, CONTINUED
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- --------------------------------------------------------------------------------------------------------------------------------
<C> <S> <C> <C> <C>
PUBLIC FACILITIES REVENUE (4.6%)
Anaheim Public Financing Authority,
$ 4,000 Sub 1997 Ser C (FSA)......................................................... 6.00% 09/01/16 $ 4,589,400
20,000 Sub 1997 Ser C (FSA)......................................................... 0.00 09/01/26 4,794,000
10,000 Beverly Hills Public Financing Authority, 1993 Refg Ser A (MBIA)............... 5.65 06/01/15 10,525,400
5,000 California Public Works Board, Department of Corrections 1998 Ser B (MBIA)..... 5.00 09/01/21 4,966,150
9,500 Los Angeles County, Public Properties Refg of 1987 COPs........................ 0.00 04/01/04 6,856,055
10,000 San Jose Financing Authority, Convention Center Refg 1993 Ser C................ 6.375 09/01/13 10,643,100
------------
- ---------
42,374,105
58,500
------------
- ---------
TAX ALLOCATION REVENUE (6.6%)
Garden Grove Community Redevelopment Agency,
5,000 Refg Issue of 1993........................................................... 5.70 10/01/13 5,224,200
6,000 Refg Issue of 1993........................................................... 5.875 10/01/23 6,279,600
25,500 Long Beach Financing Authority, Ser 1992 (AMBAC)............................... 6.00 11/01/17 29,236,260
8,905 Pleasanton Joint Powers Financing Authority, Reassessment 1993 Ser A........... 6.15 09/02/12 9,579,554
10,000 San Jose Redevelopment Agency, Ser 1998 (AMBAC) (WI)........................... 4.75 08/01/23 9,593,400
------------
- ---------
59,913,014
55,405
------------
- ---------
TRANSPORTATION FACILITIES REVENUE (21.4%)
15,000 Foothill/Eastern Transportation Corridor Agency, Toll Road Sr Lien Ser 1995 A.. 6.00 01/01/34 16,030,050
Long Beach,
5,000 Harbor Refg Ser 1998 A (AMT) (FGIC).......................................... 6.00 05/15/17 5,671,350
9,000 Harbor Refg Ser 1998 A (AMT) (FGIC).......................................... 6.00 05/15/18 10,199,610
3,000 Harbor Refg Ser 1998 A (AMT) (FGIC).......................................... 6.00 05/15/19 3,399,480
20,000 Harbor Ser 1995 (AMT) (MBIA)................................................. 5.25 05/15/25 20,119,800
10,000 Los Angeles, Department of Airports Refg 1985 Ser A (FGIC)..................... 5.50 05/15/09 10,844,900
20,000 Los Angeles County Transportation Commission, Sales Tax Ser 1991 B............. 6.50 07/01/13 21,612,999
5,000 Orange County, Airport Refg Ser 1997 (MBIA) (AMT).............................. 5.50 07/01/11 5,430,050
20,000 San Diego County Regional Transportation Commission, Sales Tax 1994 Ser A
(FGIC)....................................................................... 4.75 04/01/08 20,936,200
San Francisco Airports Commission,
5,000 San Francisco Int'l Airport Second Ser Refg Issue 4 (MBIA)................... 6.00 05/01/20 5,464,100
13,970 San Francisco Int'l Airport Second Ser Issue 15 B (MBIA)..................... 4.50 05/01/25 12,914,147
San Francisco Bay Area Rapid Transit District,
5,000 Sales Tax Ser 1995 (FGIC).................................................... 5.50 07/01/15 5,268,150
2,305 Sales Tax Ser 1995 (FGIC).................................................... 5.50 07/01/20 2,405,636
10,000 Sales Tax Ser 1998 (AMBAC)................................................... 4.75 07/01/23 9,594,600
San Joaquin Hills Transportation Corridor Agency,
6,000 Toll Road Refg Ser 1997 A (MBIA)............................................. 0.00 01/15/15 2,730,180
10,000 Toll Road Refg Ser 1997 A (MBIA)............................................. 0.00 01/15/26 2,508,800
13,450 Toll Road Refg Ser 1997 A (MBIA)............................................. 5.25 01/15/30 13,723,170
10,000 Toll Road Refg Ser 1997 A (MBIA)............................................. 0.00 01/15/31 1,942,700
10,000 Toll Road Senior Lien........................................................ 5.00 01/01/33 9,575,100
15,000 Puerto Rico Highway & Transportation Authority, Ser 1998 A..................... 4.75 07/01/38 14,208,750
------------
- ---------
194,579,772
207,725
------------
- ---------
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS
39
<PAGE>
MORGAN STANLEY DEAN WITTER CALIFORNIA TAX-FREE INCOME FUND
PORTFOLIO OF INVESTMENTS DECEMBER 31, 1998, CONTINUED
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- --------------------------------------------------------------------------------------------------------------------------------
<C> <S> <C> <C> <C>
WATER & SEWER REVENUE (18.8%)
California Department of Water Resources,
$ 6,870 Central Valley Ser J-2....................................................... 6.125% 12/01/13 $ 7,312,703
10,000 Central Valley Ser U......................................................... 5.00 12/01/29 9,890,900
8,000 Castaic Lake Water Agency, Refg Ser 1994 A COPs (MBIA)......................... 6.00 08/01/18 8,840,000
6,000 Central Coast Water Authority, Refg Ser 1996 A (AMBAC)......................... 5.00 10/01/16 6,074,400
10,000 Contra Costa Water District, Ser G (MBIA)...................................... 5.50 10/01/19 10,474,100
East Bay Municipal Utility District,
11,000 Water Refg Ser 1992.......................................................... 6.00 06/01/20 11,759,990
15,000 Water Ser 1998 (MBIA)........................................................ 4.75 06/01/34 14,284,350
10,000 Eastern Municipal Water District, Water & Sewer Refg Ser 1998 A COPs (FGIC).... 4.75 07/01/23 9,594,600
15,000 Los Angeles County Sanitation Districts Financing Authority, 1993 Ser A........ 5.375 10/01/13 15,858,449
5,745 Los Angeles, Wastewater Ser 1990............................................... 7.10 06/01/18 5,932,632
15,000 Metropolitan Water District of Southern California, Waterworks 1997 Ser A...... 5.00 07/01/26 14,867,100
San Diego,
10,000 Sewer 1993 Ser A............................................................. 5.25 05/15/20 10,161,600
10,000 Water 1998 (FGIC)............................................................ 4.75 08/01/28 9,556,200
San Diego County Water Authority,
1,500 Refg Ser 1997 A.............................................................. 4.75 05/01/18 1,467,780
3,650 Refg Ser 1997 A.............................................................. 4.75 05/01/20 3,516,994
10,000 San Diego Public Facilities Financing Authority, Sewer Ser 1995 (FGIC)......... 5.00 05/15/25 9,898,200
San Francisco Public Utilities Commission,
5,750 Water 1992 Refg Ser A........................................................ 6.00 11/01/15 6,118,863
10,870 Water 1996 Ser A............................................................. 5.00 11/01/21 10,767,061
5,000 Stockton, Wastewater, 1998 Ser A COPs (MBIA)................................... 5.00 09/01/23 4,964,600
------------
- ---------
171,340,522
169,385
------------
- ---------
OTHER REVENUE (0.2%)
1,820 Orange County Community Facilities District #86-2, Ranchc Santa Margarita Ser A
of 1990...................................................................... 7.65 08/15/17 1,909,071
------------
- ---------
REFUNDED (9.6%)
20,000 Desert Hospital District, Desert Hospital Corp Ser 1992 COPs (FSA)............. 6.392 07/28/02+ 22,022,800
Los Angeles Convention & Exhibition Center Authority,
10,000 Ser 1985 COPs................................................................ 9.00 12/01/05+ 13,073,700
14,000 Ser 1985 COPs**.............................................................. 9.00 12/01/05+ 18,303,180
5,400 Los Angeles County, 1991 Master Refg COPs...................................... 6.708 05/01/01+ 5,853,330
8,000 San Diego County Water Authority, Ser 1991- B COPs (MBIA)...................... 6.30 04/27/06+ 9,194,400
Southern California Public Power Authority,
5,000 Palo Verde Ser A (AMBAC) (ETM)............................................... 5.00 07/01/15 5,021,850
5,250 Transmission Refg Ser 1988 A (FGIC) (ETM).................................... 0.00 07/01/06 3,863,738
9,000 Puerto Rico Electric Power Authority Power Ser X............................... 6.125 07/01/05+ 10,252,170
------------
- ---------
87,585,168
76,650
------------
- ---------
TOTAL CALIFORNIA TAX-EXEMPT MUNICIPAL BONDS
(IDENTIFIED COST $813,513,630).........................................................................
875,800 879,115,539
- --------- ------------
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS
40
<PAGE>
MORGAN STANLEY DEAN WITTER CALIFORNIA TAX-FREE INCOME FUND
PORTFOLIO OF INVESTMENTS DECEMBER 31, 1998, CONTINUED
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- --------------------------------------------------------------------------------------------------------------------------------
<C> <S> <C> <C> <C>
SHORT-TERM CALIFORNIA TAX EXEMPT MUNICIPAL OBLIGATIONS (3.6%)
$ 9,700 California Economic Development Financing Authority, California Independent
System Operator Corp 1998 Ser A (Demand 01/04/99)............................ 5.00*% 04/01/08 $ 9,700,000
4,000 California Health Facilities Finacing Authority, Adventist Health 1998 Ser
(Demand 01/04/99)............................................................ 5.00* 09/01/28 4,000,000
2,500 California Statewide Communities Development Authority, John Muir/ Mt Diablo
Health Ser 1997 COPs (AMBAC) (Demand 01/04/99)............................... 4.80* 08/15/27 2,500,000
16,850 -- Newport Beach, Hoag Memorial Hospital/Presbyterian Ser 1992 (Demand
01/04/99).................................................................... 5.10* 10/01/22 16,850,000
------------
TOTAL SHORT-TERM CALIFORNIA TAX-EXEMPT MUNICIPAL OBLIGATIONS
(IDENTIFIED COST $33,050,000)..........................................................................
33,050 33,050,000
- --------- ------------
</TABLE>
<TABLE>
<C> <S> <C> <C>
$908,850 TOTAL INVESTMENTS
(IDENTIFIED COST $846,563,630) (A)......................................................... 100.1 % 912,165,539
- ---------
- ---------
LIABILITIES IN EXCESS OF CASH AND OTHER ASSETS............................................. (0.1) (1,290,351)
------ -------------
NET ASSETS................................................................................. 100.0 % $ 910,875,188
------ -------------
------ -------------
</TABLE>
- ---------------------
AMT Alternative Minimum Tax.
COPs Certificates of Participation.
ETM Escrowed to maturity.
WI Security purchased on a "when-issued" basis.
+ Prerefunded to call date shown.
* Current coupon of variable rate demand obligation.
** A portion of this security is segregated in connection with the
purchase of a "when-issued" security.
(a) The aggregate cost for federal income tax purposes approximates
identified cost. The aggregate gross unrealized appreciation is
$66,467,180 and the aggregate gross unrealized depreciation is
$865,271, resulting in net unrealized appreciation of $65,601,909.
BOND INSURANCE:
AMBAC AMBAC Indemnity Corporation.
Connie Lee Connie Lee Insurance Company.
FGIC Financial Guaranty Insurance Company.
FSA Financial Security Assurance Inc.
MBIA Municipal Bond Investors Assurance Corporation.
SEE NOTES TO FINANCIAL STATEMENTS
41
<PAGE>
MORGAN STANLEY DEAN WITTER CALIFORNIA TAX-FREE INCOME FUND
FINANCIAL STATEMENTS
STATEMENT OF ASSETS AND LIABILITIES
DECEMBER 31, 1998
<TABLE>
<S> <C>
ASSETS:
Investments in securities, at value
(identified cost $846,563,630).............................................................. $912,165,539
Cash.......................................................................................... 555,472
Receivable for:
Investments sold.......................................................................... 14,601,645
Interest.................................................................................. 12,830,104
Shares of beneficial interest sold........................................................ 436,191
Prepaid expenses and other assets............................................................. 19,353
------------
TOTAL ASSETS............................................................................. 940,608,304
------------
LIABILITIES:
Payable for:
Investments purchased..................................................................... 19,526,164
Dividends and distributions to shareholders............................................... 7,924,724
Shares of beneficial interest repurchased................................................. 917,674
Plan of distribution fee.................................................................. 583,984
Investment management fee................................................................. 417,174
Accrued expenses and other payables........................................................... 363,396
------------
TOTAL LIABILITIES........................................................................ 29,733,116
------------
NET ASSETS............................................................................... $910,875,188
------------
------------
COMPOSITION OF NET ASSETS:
Paid-in-capital............................................................................... $844,068,216
Net unrealized appreciation................................................................... 65,601,909
Accumulated undistributed net realized gain................................................... 1,205,063
------------
NET ASSETS............................................................................... $910,875,188
------------
------------
CLASS A SHARES:
Net Assets.................................................................................... $3,787,521
Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE)..................................... 297,006
NET ASSET VALUE PER SHARE................................................................ $12.75
------------
------------
MAXIMUM OFFERING PRICE PER SHARE,
(NET ASSET VALUE PLUS 4.44% OF NET ASSET VALUE)........................................ $13.32
------------
------------
CLASS B SHARES:
Net Assets.................................................................................... $896,685,119
Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE)..................................... 69,982,582
NET ASSET VALUE PER SHARE................................................................ $12.81
------------
------------
CLASS C SHARES:
Net Assets.................................................................................... $9,848,975
Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE)..................................... 768,977
NET ASSET VALUE PER SHARE................................................................ $12.81
------------
------------
CLASS D SHARES:
Net Assets.................................................................................... $553,573
Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE)..................................... 43,311
NET ASSET VALUE PER SHARE................................................................ $12.78
------------
------------
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS
42
<PAGE>
MORGAN STANLEY DEAN WITTER CALIFORNIA TAX-FREE INCOME FUND
FINANCIAL STATEMENTS, CONTINUED
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1998
<TABLE>
<S> <C>
NET INVESTMENT INCOME:
INTEREST INCOME................................................................................ $49,290,397
-----------
EXPENSES
Investment management fee...................................................................... 4,871,646
Plan of distribution fee (Class A shares)...................................................... 6,337
Plan of distribution fee (Class B shares)...................................................... 6,763,732
Plan of distribution fee (Class C shares)...................................................... 53,763
Transfer agent fees and expenses............................................................... 231,855
Shareholder reports and notices................................................................ 62,131
Professional fees.............................................................................. 53,728
Custodian fees................................................................................. 36,260
Trustees' fees and expenses.................................................................... 18,799
Registration fees.............................................................................. 7,265
Other.......................................................................................... 32,060
-----------
TOTAL EXPENSES............................................................................ 12,137,576
Less: expense offset........................................................................... (36,170)
Less: plan of distribution fee rebate (Class B shares)......................................... (3,465,883)
-----------
NET EXPENSES.............................................................................. 8,635,523
-----------
NET INVESTMENT INCOME..................................................................... 40,654,874
-----------
NET REALIZED AND UNREALIZED GAIN (LOSS):
Net realized gain.............................................................................. 17,556,128
Net change in unrealized appreciation.......................................................... (8,093,340)
-----------
NET GAIN.................................................................................. 9,462,788
-----------
NET INCREASE................................................................................... $50,117,662
-----------
-----------
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS
43
<PAGE>
MORGAN STANLEY DEAN WITTER CALIFORNIA TAX-FREE INCOME FUND
FINANCIAL STATEMENTS, CONTINUED
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
FOR THE YEAR FOR THE YEAR
ENDED ENDED
DECEMBER 31, 1998 DECEMBER 31, 1997*
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE (DECREASE) IN NET ASSETS:
OPERATIONS:
Net investment income................................................ $ 40,654,874 $ 41,943,761
Net realized gain.................................................... 17,556,128 917,033
Net change in unrealized appreciation................................ (8,093,340 ) 23,634,172
----------------- ------------------
NET INCREASE.................................................... 50,117,662 66,494,966
----------------- ------------------
DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income
Class A shares................................................... (113,998 ) (2,074 )
Class B shares................................................... (40,239,955 ) (41,903,238 )
Class C shares................................................... (287,533 ) (38,101 )
Class D shares................................................... (13,388 ) (348 )
Net realized gain
Class A shares................................................... (69,921 ) --
Class B shares................................................... (16,702,217 ) --
Class C shares................................................... (181,009 ) --
Class D shares................................................... (10,153 ) --
----------------- ------------------
TOTAL DIVIDENDS AND DISTRIBUTIONS............................... (57,618,174 ) (41,943,761 )
----------------- ------------------
Net decrease from transactions in shares of beneficial interest...... (928,349 ) (80,949,361 )
----------------- ------------------
NET DECREASE.................................................... (8,428,861 ) (56,398,156 )
NET ASSETS:
Beginning of period.................................................. 919,304,049 975,702,205
----------------- ------------------
END OF PERIOD................................................... $ 910,875,188 $ 919,304,049
----------------- ------------------
----------------- ------------------
</TABLE>
- ---------------------
* Class A, Class C and Class D shares were issued July 28, 1997.
SEE NOTES TO FINANCIAL STATEMENTS
44
<PAGE>
MORGAN STANLEY DEAN WITTER CALIFORNIA TAX-FREE INCOME FUND
FINANCIAL HIGHLIGHTS
Selected ratios and per share data for a share of beneficial interest
outstanding throughout each period:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------
1998 1997* 1996 1995 1994
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
CLASS B SHARES
SELECTED PER
SHARE DATA:
Net asset value,
beginning of
period.......... $ 12.92 $ 12.57 $ 12.92 $ 11.87 $ 13.31
---------- --------- --------- ---------- ----------
Income (loss)
from investment
operations:
Net investment
income......... 0.58 0.57 0.58 0.61 0.64
Net realized
and unrealized
gain........... 0.13 0.35 (0.21) 1.13 (1.42)
---------- --------- --------- ---------- ----------
Total income
(loss) from
investment
operations...... 0.71 0.92 0.37 1.74 (0.78)
---------- --------- --------- ---------- ----------
Less dividends
and
distributions
from:
Net investment
income......... (0.58) (0.57) (0.58) (0.61) (0.64)
Net realized
gain........... (0.24) -- (0.14) (0.08) (0.02)
---------- --------- --------- ---------- ----------
Total dividends
and
distributions... (0.82) (0.57) (0.72) (0.69) (0.66)
---------- --------- --------- ---------- ----------
Net asset value,
end of period... $ 12.81 $ 12.92 $ 12.57 $ 12.92 $ 11.87
---------- --------- --------- ---------- ----------
---------- --------- --------- ---------- ----------
TOTAL RETURN+.... 5.63% 7.51% 3.13% 14.96% (5.97)%
RATIOS TO AVERAGE
NET ASSETS:
Expenses......... 0.95%(2)(3) 1.33% 1.32%(1) 1.33% 1.32%
Net investment
income.......... 4.46%(2)(3) 4.51% 4.66% 4.90% 5.10%
SUPPLEMENTAL DATA:
Net assets, end
of period, in
millions........ $897 $914 $976 $1,055 $1,008
Portfolio
turnover rate... 20% 15% 11% 23% 12%
</TABLE>
- ---------------------
* Prior to July 28, 1997, the Fund issued one class of shares. All shares of
the Fund held prior to that date have been designated Class B shares.
+ Does not reflect the deduction of sales charge. Calculated based on the net
asset value as of the last business day of the period.
(1) Does not reflect the effect of expense offset of 0.01%.
(2) Reflects overall Fund ratios for investment income and non-class specific
expenses.
(3) If the Distributor had not rebated a portion of its fees to the Fund, the
expense and net investment income ratios would have been 1.33% and 4.08%,
respectively.
SEE NOTES TO FINANCIAL STATEMENTS
45
<PAGE>
MORGAN STANLEY DEAN WITTER CALIFORNIA TAX-FREE INCOME FUND
FINANCIAL HIGHLIGHTS, CONTINUED
<TABLE>
<CAPTION>
FOR THE PERIOD
FOR THE YEAR JULY 28, 1997*
ENDED THROUGH
DECEMBER 31, DECEMBER 31,
1998 1997
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C>
CLASS A SHARES
SELECTED PER SHARE DATA:
Net asset value, beginning of period.................................. $ 12.89 $ 12.80
------ ------
Income from investment operations:
Net investment income.............................................. 0.59 0.27
Net realized and unrealized gain................................... 0.10 0.09
------ ------
Total income from investment operations............................... 0.69 0.36
------ ------
Less dividends and distributions from:
Net investment income.............................................. (0.59) (0.27)
Net realized gain.................................................. (0.24) --
------ ------
Total dividends and distributions..................................... (0.83) (0.27)
------ ------
Net asset value, end of period........................................ $ 12.75 $ 12.89
------ ------
------ ------
TOTAL RETURN+......................................................... 5.50% 2.82%(1)
RATIOS TO AVERAGE NET ASSETS:
Expenses.............................................................. 0.83%(3) 0.78%(2)
Net investment income................................................. 4.58%(3) 4.47%(2)
SUPPLEMENTAL DATA:
Net assets, end of period, in thousands............................... $3,788 $1,175
Portfolio turnover rate............................................... 20% 15%
</TABLE>
<TABLE>
<S> <C> <C>
CLASS C SHARES
SELECTED PER SHARE DATA:
Net asset value, beginning of period.................................. $ 12.92 $ 12.80
------ ------
Income from investment operations:
Net investment income.............................................. 0.53 0.23
Net realized and unrealized gain................................... 0.13 0.12
------ ------
Total income from investment operations............................... 0.66 0.35
------ ------
Less dividends and distributions from:
Net investment income.............................................. (0.53) (0.23)
Net realized gain.................................................. (0.24) --
------ ------
Total dividends and distributions..................................... (0.77) (0.23)
------ ------
Net asset value, end of period........................................ $ 12.81 $ 12.92
------ ------
------ ------
TOTAL RETURN+......................................................... 5.22% 2.80%(1)
RATIOS TO AVERAGE NET ASSETS:
Expenses.............................................................. 1.33%(3) 1.31%(2)
Net investment income................................................. 4.08%(3) 4.24%(2)
SUPPLEMENTAL DATA:
Net assets, end of period, in thousands............................... $9,849 $3,610
Portfolio turnover rate............................................... 20% 15%
</TABLE>
- ---------------------
* The date shares were first issued.
+ Does not reflect the deduction of sales charge. Calculated based on the net
asset value as of the last business day of the period.
(1) Not annualized.
(2) Annualized.
(3) Reflects overall Fund ratios for investment income and non-class specific
expenses.
SEE NOTES TO FINANCIAL STATEMENTS
46
<PAGE>
MORGAN STANLEY DEAN WITTER CALIFORNIA TAX-FREE INCOME FUND
FINANCIAL HIGHLIGHTS, CONTINUED
<TABLE>
<CAPTION>
FOR THE PERIOD
FOR THE YEAR JULY 28, 1997*
ENDED THROUGH
DECEMBER 31, DECEMBER 31,
1998 1997
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C>
CLASS D SHARES
SELECTED PER SHARE DATA:
Net asset value, beginning of period.................................. $ 12.92 $ 12.80
------ ------
Income from investment operations:
Net investment income............................................... 0.63 0.28
Net realized and unrealized gain.................................... 0.10 0.12
------ ------
Total income from investment operations............................... 0.73 0.40
------ ------
Less dividends and distributions from:
Net investment income............................................... (0.63) (0.28)
Net realized gain................................................... (0.24) --
------ ------
Total dividends and distributions..................................... (0.87) (0.28)
------ ------
Net asset value, end of period........................................ $ 12.78 $ 12.92
------ ------
------ ------
TOTAL RETURN+......................................................... 5.77% 3.18%(1)
RATIOS TO AVERAGE NET ASSETS:
Expenses.............................................................. 0.58%(3) 0.60%(2)
Net investment income................................................. 4.83%(3) 5.34%(2)
SUPPLEMENTAL DATA:
Net assets, end of period, in thousands............................... $554 $45
Portfolio turnover rate............................................... 20% 15%
</TABLE>
- ---------------------
* The date shares were first issued.
+ Calculated based on the net asset value as of the last business day of the
period.
(1) Not annualized.
(2) Annualized.
(3) Reflects overall Fund ratios for investment income and non-class specific
expenses.
SEE NOTES TO FINANCIAL STATEMENTS
47
<PAGE>
MORGAN STANLEY DEAN WITTER CALIFORNIA TAX-FREE INCOME FUND
NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1998
1. ORGANIZATION AND ACCOUNTING POLICIES
Morgan Stanley Dean Witter California Tax-Free Income Fund (the "Fund"),
formerly Dean Witter California Tax-Free Income Fund, is registered under the
Investment Company Act of 1940, as amended (the "Act"), as a diversified,
open-end management investment company. The Fund's investment objective is to
provide a high level of current income which is exempt from federal and
California income tax, consistent with the preservation of capital. The Fund was
organized as a Massachusetts business trust on April 9, 1984 and commenced
operations on July 11, 1984. On July 28, 1997, the Fund commenced offering three
additional classes of shares, with the then current shares designated as Class B
shares.
The Fund offers Class A shares, Class B shares, Class C shares and Class D
shares. The four classes are substantially the same except that most Class A
shares are subject to a sales charge imposed at the time of purchase and some
Class A shares, and most Class B shares and Class C shares are subject to a
contingent deferred sales charge imposed on shares redeemed within one year, six
years and one year, respectively. Class D shares are not subject to a sales
charge. Additionally, Class A shares, Class B shares and Class C shares incur
distribution expenses.
The preparation of financial statements in accordance with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts and disclosures. Actual results could differ from
those estimates.
The following is a summary of significant accounting policies:
A. VALUATION OF INVESTMENTS -- Portfolio securities are valued for the Fund by
an outside independent pricing service approved by the Trustees. The pricing
service has informed the Fund that in valuing the Fund's portfolio securities,
it uses both a computerized matrix of tax-exempt securities and evaluations by
its staff, in each case based on information concerning market transactions and
quotations from dealers which reflect the bid side of the market each day. The
Fund's portfolio securities are thus valued by reference to a combination of
transactions and quotations for the same or other securities believed to be
comparable in quality, coupon, maturity, type of issue, call provisions, trading
characteristics and other features deemed to be relevant. Short-term debt
securities having a maturity date of more than sixty days at time of purchase
are valued on a mark-to-market basis until sixty days prior to maturity and
thereafter at amortized cost based on their value on the 61st day. Short-term
debt securities having a maturity date of sixty days or less at the time of
purchase are valued at amortized cost.
48
<PAGE>
MORGAN STANLEY DEAN WITTER CALIFORNIA TAX-FREE INCOME FUND
NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1998, CONTINUED
B. ACCOUNTING FOR INVESTMENTS -- Security transactions are accounted for on the
trade date (date the order to buy or sell is executed). Realized gains and
losses on security transactions are determined by the identified cost method.
The Fund amortizes premiums and accretes discounts over the life of the
respective securities. Interest income is accrued daily.
C. MULTIPLE CLASS ALLOCATIONS -- Investment income, expenses (other than
distribution fees), and realized and unrealized gains and losses are allocated
to each class of shares based upon the relative net asset value on the date such
items are recognized. Distribution fees are charged directly to the respective
class.
D. FEDERAL INCOME TAX STATUS -- It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated investment
companies and to distribute all of its taxable and nontaxable income to its
shareholders. Accordingly, no federal income tax provision is required.
E. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS -- The Fund records dividends and
distributions to its shareholders on the record date. The amount of dividends
and distributions from net investment income and net realized capital gains are
determined in accordance with federal income tax regulations which may differ
from generally accepted accounting principles. These "book/tax" differences are
either considered temporary or permanent in nature. To the extent these
differences are permanent in nature, such amounts are reclassified within the
capital accounts based on their federal tax-basis treatment; temporary
differences do not require reclassification. Dividends and distributions which
exceed net investment income and net realized capital gains for financial
reporting purposes but not for tax purposes are reported as dividends in excess
of net investment income or distributions in excess of net realized capital
gains. To the extent they exceed net investment income and net realized capital
gains for tax purposes, they are reported as distributions of paid-in-capital.
2. INVESTMENT MANAGEMENT AGREEMENT
Pursuant to an Investment Management Agreement with Morgan Stanley Dean Witter
Advisors Inc. (the "Investment Manager"), formerly Dean Witter InterCapital
Inc., the Fund pays the Investment Manager a management fee, accrued daily and
payable monthly, by applying the following annual rates to the Fund's net assets
determined as of the close of each business day: 0.55% to the portion of daily
net assets not exceeding $500 million; 0.525% to the portion of daily net assets
exceeding $500 million but not exceeding $750 million; 0.50% to the portion of
daily net assets exceeding
49
<PAGE>
MORGAN STANLEY DEAN WITTER CALIFORNIA TAX-FREE INCOME FUND
NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1998, CONTINUED
$750 million but not exceeding $1 billion; 0.475% to the portion of daily net
assets exceeding $1 billion but not exceeding $1.25 billion; and 0.45% to the
portion of daily net assets in excess of $1.25 billion.
Under the terms of the Agreement, in addition to managing the Fund's
investments, the Investment Manager maintains certain of the Fund's books and
records and furnishes, at its own expense, office space, facilities, equipment,
clerical, bookkeeping and certain legal services and pays the salaries of all
personnel, including officers of the Fund who are employees of the Investment
Manager. The Investment Manager also bears the cost of telephone services, heat,
light, power and other utilities provided to the Fund.
3. PLAN OF DISTRIBUTION
Shares of the Fund are distributed by Morgan Stanley Dean Witter Distributors
Inc. (the "Distributor"), an affiliate of the Investment Manager. The Fund has
adopted a Plan of Distribution (the "Plan") pursuant to Rule 12b-1 under the
Act. The Plan provides that the Fund will pay the Distributor a fee which is
accrued daily and paid monthly at the following annual rates: (i) Class A -- up
to 0.25% of the average daily net assets of Class A; (ii) Class B -- 0.75% of
the lesser of: (a) the average daily aggregate gross sales of the Class B shares
since the inception of the Fund (not including reinvestment of dividend or
capital gain distributions) less the average daily aggregate net asset value of
the Class B shares redeemed since the Fund's inception upon which a contingent
deferred sales charge has been imposed or waived; or (b) the average daily net
assets of Class B; and (iii) Class C -- up to 0.75% of the average daily net
assets of Class C. In the case of Class A shares, amounts paid under the Plan
are paid to the Distributor for services provided. In the case of Class B and
Class C shares, amounts paid under the Plan are paid to the Distributor for (1)
services provided and the expenses borne by it and others in the distribution of
the shares of these Classes, including the payment of commissions for sales of
these Classes and incentive compensation to, and expenses of, the Morgan Stanley
Dean Witter Financial Advisors and others who engage in or support distribution
of the shares or who service shareholder accounts, including overhead and
telephone expenses;(2) printing and distribution of prospectuses and reports
used in connection with the offering of these shares to other than current
shareholders; and (3) preparation, printing and distribution of sales literature
and advertising materials. In addition, the Distributor may utilize fees paid
pursuant to the Plan, in the case of Class B shares, to compensate Dean Witter
Reynolds Inc.
50
<PAGE>
MORGAN STANLEY DEAN WITTER CALIFORNIA TAX-FREE INCOME FUND
NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1998, CONTINUED
("DWR"), an affiliate of the Investment Manager and Distributor, and other
selected broker-dealers for their opportunity costs in advancing such amounts,
which compensation would be in the form of a carrying charge on any unreimbursed
expenses.
In the case of Class B shares, provided that the Plan continues in effect, any
cumulative expenses incurred by the Distributor but not yet recovered may be
recovered through the payment of future distribution fees from the Fund pursuant
to the Plan and contingent deferred sales charges paid by investors upon
redemption of Class B shares. Although there is no legal obligation for the Fund
to pay expenses incurred in excess of payments made to the Distributor under the
Plan and the proceeds of contingent deferred sales charges paid by investors
upon redemption of shares, if for any reason the Plan is terminated, the
Trustees will consider at that time the manner in which to treat such expenses.
The Distributor has advised the Fund that there were no excess expenses as of
December 31, 1998.
For the year ended December 31, 1998, the Distributor rebated a portion of the
distribution fees paid by the fund on Class B shares in the amount of
$3,465,883.
In the case of Class A shares and Class C shares, expenses incurred pursuant to
the Plan in any calendar year in excess of 0.25% or 0.75% of the average daily
net assets of Class A or Class C, respectively, will not be reimbursed by the
Fund through payments in any subsequent year, except that expenses representing
a gross sales credit to Morgan Stanley Dean Witter Financial Advisors or other
selected broker-dealer representatives may be reimbursed in the subsequent
calendar year. For the year ended December 31, 1998, the distribution fee was
accrued for Class A shares and Class C shares at the annual rate of 0.25% and
0.75%, respectively.
The Distributor has informed the Fund that for the year ended December 31, 1998,
it received contingent deferred sales charges from certain redemptions of the
Fund's Class B shares and Class C shares of $694,975 and $1,943, respectively
and received $43,401 in front-end sales charges from sales of the Fund's Class A
shares. The respective shareholders pay such charges which are not an expense of
the Fund.
4. SECURITY TRANSACTIONS AND TRANSACTIONS WITH AFFILIATES
The cost of purchases and proceeds from sales of portfolio securities, excluding
short-term investments, for the year ended December 31, 1998 aggregated
$171,196,945 and $211,293,988, respectively.
51
<PAGE>
MORGAN STANLEY DEAN WITTER CALIFORNIA TAX-FREE INCOME FUND
NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1998, CONTINUED
Morgan Stanley Dean Witter Trust FSB, an affiliate of the Investment Manager and
Distributor, is the Fund's transfer agent. At December 31, 1998, the Fund had
transfer agent fees and expenses payable of approximately $10,500.
The Fund has an unfunded noncontributory defined benefit pension plan covering
all independent Trustees of the Fund who will have served as independent
Trustees for at least five years at the time of retirement. Benefits under this
plan are based on years of service and compensation during the last five years
of service. Aggregate pension costs for the year ended December 31, 1998
included in Trustees' fees and expenses in the Statement of Operations amounted
to $6,120. At December 31, 1998, the Fund had an accrued pension liability of
$51,231 which is included in accrued expenses in the Statement of Assets and
Liabilities.
5. SHARES OF BENEFICIAL INTEREST
Transactions in shares of beneficial interest were as follows:
<TABLE>
<CAPTION>
FOR THE YEAR FOR THE YEAR
ENDED ENDED
DECEMBER 31, 1998 DECEMBER 31, 1997*
---------------------------- --------------------------
SHARES AMOUNT SHARES AMOUNT
----------- -------------- ----------- ------------
<S> <C> <C> <C> <C>
CLASS A SHARES
Sold............................................................. 278,438 $ 3,615,711 91,032 $ 1,171,264
Reinvestment of dividends and distributions...................... 4,755 60,900 98 1,257
Redeemed......................................................... (77,317) (1,003,589) -- --
----------- -------------- ----------- ------------
Net increase - Class A........................................... 205,876 2,673,022 91,130 1,172,521
----------- -------------- ----------- ------------
CLASS B SHARES
Sold............................................................. 7,164,773 93,003,382 5,189,823 65,387,817
Reinvestment of dividends and distributions...................... 2,410,233 31,062,347 1,737,487 21,926,214
Redeemed......................................................... (10,377,338) (134,515,057) (13,733,885) (173,042,410)
----------- -------------- ----------- ------------
Net decrease - Class B........................................... (802,332) (10,449,328) (6,806,575) (85,728,379)
----------- -------------- ----------- ------------
CLASS C SHARES
Sold............................................................. 503,894 6,520,311 279,066 3,558,314
Reinvestment of dividends and distributions...................... 29,925 385,668 2,255 28,911
Redeemed......................................................... (44,199) (576,331) (1,964) (25,237)
----------- -------------- ----------- ------------
Net increase - Class C........................................... 489,620 6,329,648 279,357 3,561,988
----------- -------------- ----------- ------------
CLASS D SHARES
Sold............................................................. 39,412 512,790 3,442 44,176
Reinvestment of dividends and distributions...................... 431 5,519 26 333
----------- -------------- ----------- ------------
Net increase - Class D........................................... 39,843 518,309 3,468 44,509
----------- -------------- ----------- ------------
Net decrease in Fund............................................. (66,993) $ (928,349) (6,432,620) $(80,949,361)
----------- -------------- ----------- ------------
----------- -------------- ----------- ------------
</TABLE>
- ---------------------
* For Class A, C and D shares, for the period July 28, 1997 (issue date)
through December 31, 1997.
52
<PAGE>
MORGAN STANLEY DEAN WITTER CALIFORNIA TAX- FREE
INCOME FUND
REPORT OF INDEPENDENT ACCOUNTANTS
TO THE SHAREHOLDERS AND TRUSTEES
OF MORGAN STANLEY DEAN WITTER CALIFORNIA TAX-FREE INCOME FUND
In our opinion, the accompanying statement of assets and liabilities, including
the portfolio of investments, and the related statements of operations and of
changes in net assets and the financial highlights present fairly, in all
material respects, the financial position of Morgan Stanley Dean Witter
California Tax-Free Income Fund (the "Fund"), formerly Dean Witter California
Tax-Free Income Fund, at December 31, 1998, the results of its operations for
the year then ended, the changes in its net assets for each of the two years in
the period then ended and the financial highlights for each of the periods
presented, in conformity with generally accepted accounting principles. These
financial statements and financial highlights (hereafter referred to as
"financial statements") are the responsibility of the Fund's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these financial statements in accordance
with generally accepted auditing standards which require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits, which included confirmation of securities at
December 31, 1998 by correspondence with the custodian and brokers, provide a
reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
1177 AVENUE OF THE AMERICAS
NEW YORK, NEW YORK 10036
FEBRUARY 10, 1999
1998 FEDERAL TAX NOTICE (UNAUDITED)
During the year ended December 31, 1998, the Fund paid to
shareholders the following per share amounts from net investment
income: Class A, $0.59; Class B, $0.58; Class C, $0.53; and Class
D, $0.63 per share. All of these dividends from net investment
income were exempt interest dividends, excludable from gross
income for Federal income tax purposes. For the year ended
December 31, 1998 the Fund paid to Class A, B, C and D
shareholders $0.24 per share from long-term capital gains, all of
which is taxable as 20% rate gain.
53
<PAGE>
APPENDIX
- --------------------------------------------------------------------------------
RATINGS OF INVESTMENTS
MOODY'S INVESTORS SERVICE INC. ("MOODY'S")
MUNICIPAL BOND RATINGS
<TABLE>
<S> <C>
Aaa Bonds which are rated Aaa are judged to be of the best quality. They carry the
smallest degree of investment risk and are generally referred to as "gilt edge."
Interest payments are protected by a large or by an exceptionally stable margin and
principal is secure. While the various protective elements are likely to change, such
changes as can be visualized are most unlikely to impair the fundamentally strong
position of such issues.
Aa Bonds which are rated Aa are judged to be of high quality by all standards. Together
with the Aaa group they comprise what are generally known as high grade bonds. They
are rated lower than the best bonds because margins of protection may not be as large
as in Aaa securities or fluctuation of protective elements may be of greater
amplitude or there may be other elements present which make the long-term risks
appear somewhat larger than in Aaa securities.
A Bonds which are rated A possess many favorable investment attributes and are to be
considered as upper medium grade obligations. Factors giving security to principal
and interest are considered adequate, but elements may be present which suggest a
susceptibility to impairment sometime in the future.
Baa Bonds which are rated Baa are considered as medium grade obligation; i.e., they are
neither highly protected nor poorly secured. Interest payments and principal security
appear adequate for the present but certain protective elements may be lacking or may
be characteristically unreliable over any great length of time. Such bonds lack
outstanding investment characteristics and in fact have speculative characteristics
as well.
Bonds rated Aaa, Aa, A and Baa are considered investment grade bonds.
Ba Bonds which are rated Ba are judged to have speculative elements; their future cannot
be considered as well assured. Often the protection of interest and principal
payments may be very moderate, and therefore not well safeguarded during both good
and bad times over the future. Uncertainty of position characterizes bonds in this
class.
B Bonds which are rated B generally lack characteristics of a desirable investment.
Assurance of interest and principal payments or of maintenance of other terms of the
contract over any long period of time may be small.
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 present 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 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.
</TABLE>
CONDITIONAL RATING: Bonds for which the security depends upon the
completion of some act of the fulfillment of some condition are rated
conditionally. These are bonds secured by (a) earnings of projects under
construction, (b) earnings of projects unseasoned in operation experience, (c)
rentals which begin when facilities are completed, or (d) payments to which some
other limiting condition attaches. Parenthetical rating denotes probable credit
stature upon completion of construction or elimination of basis of condition.
54
<PAGE>
RATING REFINEMENTS: Moody's may apply numerical modifiers, 1, 2 and 3 in
each generic rating classification from Aa through B in its municipal bond
rating system. The modifier 1 indicates a mid-range ranking; and a modifier 3
indicates that the issue ranks in the lower end of its generic rating category.
MUNICIPAL NOTE RATINGS
Moody's ratings for state and municipal notes and other short-term loans are
designated Moody's Investment Grade (MIG). MIG 1 denotes best quality and means
there is present strong protection from established cash flows, superior
liquidity support or demonstrated broad-based access to the market for
refinancing. MIG 2 denotes high quality and means that margins of protection are
ample although not as large as in MIG 1. MIG 3 denotes favorable quality and
means that all security elements are accounted for but that the undeniable
strength of the previous grades, MIG 1 and MIG 2, is lacking. MIG 4 denotes
adequate quality and means that the protection commonly regarded as required of
an investment security is present and that while the notes are not distinctly or
predominantly speculative, there is specific risk.
VARIABLE RATE DEMAND OBLIGATIONS
A short-term rating, in addition to the Bond or MIG ratings, designated VMIG
may also be assigned to an issue having a demand feature. The assignment of the
VMIG symbol reflects such characteristics as payment upon periodic demand rather
than fixed maturity dates and payment relying on external liquidity. The VMIG
rating criteria are identical to the MIG criteria discussed above.
COMMERCIAL PAPER RATINGS
Moody's Commercial Paper ratings are opinions of the ability to repay
punctually promissory obligations not having an original maturity in excess of
nine months. These ratings apply to Municipal commercial Paper as well as
taxable Commercial Paper. Moody's employs the following three designations, all
judged to be investment grade, to indicate the relative repayment capacity of
rated issuers: Prime-1, Prime-2, Prime-3.
Issuers rated Prime-1 have a superior capacity for repayment of short-term
promissory obligations. Issuers rated Prime-2 have a strong capacity for
repayment of short-term promissory obligations; and Issuers rated Prime-3 have
an acceptable capacity for repayment of short-term promissory obligations.
Issuers rated Not Prime do not fall within any of the Prime rating categories.
STANDARD & POOR'S CORPORATION ("STANDARD & POOR'S")
MUNICIPAL BOND RATINGS
A Standard & Poor's municipal rating is a current assessment of the
creditworthiness of an obligor with respect to a specific obligation. This
assessment may take into consideration obligors such as guarantors, insurers, or
lessees.
The ratings are based on current information furnished by the issuer or
obtained by Standard & Poor's from other sources it considers reliable. The
ratings are based, in varying degrees, on the following considerations: (1)
likelihood of default-capacity and willingness of the obligor as to the timely
payment of interest and repayment of principal in accordance with the terms of
the obligation; (2) nature of and provisions of the obligation; and (3)
protection afforded by, and relative position of, the obligation in the event of
bankruptcy, reorganization or other arrangement under the laws of bankruptcy and
other laws affecting creditors' rights.
Standard & Poor's does not perform an audit in connection with any rating
and may, on occasion, rely on unaudited financial information. The ratings may
be changed, suspended or withdrawn as a result of changes in, or unavailability
of, such information, or for other reasons.
55
<PAGE>
<TABLE>
<S> <C>
AAA Debt rated "AAA" has the highest rating assigned by Standard & Poor's. Capacity to
pay interest and repay principal is extremely strong.
AA Debt rated "AA" has a very strong capacity to pay interest and repay principal and
differs from the highest-rated issues only in small degree.
A Debt rated "A" has a strong capacity to pay interest and repay principal although
they are somewhat more susceptible to the adverse effects of changes in circumstances
and economic conditions than debt in higher-rated categories.
BBB Debt rated "BBB" is regarded as having an adequate capacity to pay interest and repay
principal. Whereas it normally exhibits adequate protection parameters, adverse
economic conditions or changing circumstances are more likely to lead to a weakened
capacity to pay interest and repay principal for debt in this category than for debt
in higher-rated categories.
Bonds rated AAA, AA, A and BBB are considered investment grade bonds.
BB Debt rated "BB" has less near-term vulnerability to default than other speculative
grade debt. However, it faces major ongoing uncertainties or exposure to adverse
business, financial or economic conditions which could lead to inadequate capacity to
meet timely interest and principal payment.
B Debt rated "B" has a greater vulnerability to default but presently has the capacity
to meet interest payments and principal repayments. Adverse business, financial or
economic conditions would likely impair capacity or willingness to pay interest and
repay principal.
CCC Debt rated "CCC" has a current identifiable vulnerability to default, and is
dependent upon favorable business, financial and economic conditions to meet timely
payments of interest and repayments of principal. In the event of adverse business,
financial or economic conditions, it is not likely to have the capacity to pay
interest and repay principal.
CC The rating "CC" is typically applied to debt subordinated to senior debt which is
assigned an actual or implied "CCC" rating.
C The rating "C" is typically applied to debt subordinated to senior debt which is
assigned an actual or implied "CCC" debt rating.
Cl The rating "Cl" 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 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.
NR Indicates that no rating has been requested, that there is insufficient information
on which to base a rating or that Standard & Poor's does not rate a particular type
of obligation as a matter of policy.
Bonds rated "BB", "B", "CCC", "CC" and "C" are regarded as having predominantly
speculative characteristics with respect to capacity to pay interest and repay
principal. "BB" indicates the least 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.
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 ratings
categories.
</TABLE>
56
<PAGE>
<TABLE>
<S> <C>
The foregoing ratings are sometimes followed by a "p" which indicates that the rating
is provisional. A provisional rating assumes the successful completion of the project
being financed by the bonds being rated and indicates that payment of debt service
requirements is largely or entirely dependent upon the successful and timely
completion of the project. This rating, however, while addressing credit quality
subsequent to completion of the project, makes no comment on the likelihood or risk
of default upon failure of such completion.
</TABLE>
MUNICIPAL NOTE RATINGS
Commencing on July 27, 1984, Standard & Poor's instituted a new rating
category with respect to certain municipal note issues with a maturity of less
than three years. The new note ratings denote the following:
SP-1 denotes a very strong or strong capacity to pay principal and interest.
Issues determined to possess overwhelming safety characteristics are given a
plus (+) designation (SP-1+).
SP-2 denotes a satisfactory capacity to pay principal and interest.
SP-3 denotes a speculative capacity to pay principal and interest.
COMMERCIAL PAPER RATINGS
Standard and Poor's commerical paper rating is a current assessment of the
likelihood of timely payment of debt having an original maturity of no more than
365 days. The commercial paper rating is not a recommendation to purchase or
sell a security. The ratings are based upon current information furnished by the
issuer or obtained by S&P from other sources it considers reliable. The ratings
may be changed, suspended, or withdrawn as a result of changes in or
unavailability of such information. Ratings are graded into group categories,
ranging from "A" for the highest quality obligations to "D" for the lowest.
Ratings are applicable to both taxable and tax-exempt commercial paper. The
categories are as follows:
Issues assigned A ratings are regarded as having the greatest capacity for
timely payment. Issues in this category are further refined with the designation
1, 2 and 3 to indicate the relative degree of safety.
A-1 indicates that the degree of safety regarding timely payments is very
strong.
A-2 indicates capacity for timely payment on issues with this designation is
strong. However, the relative degree of safety is not as overwhelming as for
issues designated "A-1".
A-3 indicates a satisfactory capacity for timely payment. Obligations
carrying this designation are, however, somewhat more vulnerable to the adverse
effects of changes in circumstances than obligations carrying the higher
designations.
57
<PAGE>
FITCH IBCA, INC. ("FITCH")
MUNICIPAL BOND RATINGS
Fitch investment grade bond ratings provide a guide to investors in
determining the credit risk associated with a particular security. The rating
represents Fitch's assessment of the issuer's ability to meet the obligations of
a specific debt issue or class of debt in a timely manner.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and any guarantor,
as well as the economic and political environment that might affect the issuer's
future financial strength and credit quality.
Fitch ratings do not reflect any credit enhancement that may be provided by
insurance policies or financial guarantees unless otherwise indicated.
Bonds carrying the same rating are of similar but not necessarily identical
credit quality since the rating categories do not fully reflect small
differences in the degrees of credit risk.
Fitch ratings are not recommendations to buy, sell, or hold any security.
Ratings do not comment on the adequacy of market price, the suitability of any
security for a particular investor, or the tax-exempt nature or taxability of
payments made in respect of any security.
Fitch ratings are based on information obtained from issuers, other
obligors, underwriters, their experts, and other sources Fitch believes to be
reliable. Fitch does not audit or verify the truth or accuracy of such
information. Ratings may be changed, suspended, or withdrawn as a result of
changes in, or the unavailability of, information or for other reasons.
<TABLE>
<S> <C>
AAA Bonds considered to be investment grade and of the highest credit quality.
The obligor has an exceptionally strong ability to pay interest and repay
principal, which is unlikely to be affected by reasonably foreseeable
events.
AA Bonds considered to be investment grade and of very high credit quality.
The obligor's ability to pay interest and repay principal is very strong,
although not quite as strong as bonds rated "AAA." Because bonds rated in
the "AAA" and "AA" categories are not significantly vulnerable to
foreseeable future developments, short-term debt of these issuers is
generally rated "F-1+."
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.
Plus (+) or Plus and minus signs are used with a rating symbol to indicate the relative
Minus (-) position of a credit within the rating category. Plus and minus signs,
however, are not used in the"AAA" category.
NR Indicates that Fitch does not rate the specific issue.
Conditional A conditional rating is premised on the successful completion of a project
or the occurrence of a specific event.
</TABLE>
58
<PAGE>
<TABLE>
<S> <C>
Suspended A rating is suspended when Fitch deems the amount of information available
from the issuer to be inadequate for rating purposes.
Withdrawn A rating will be withdrawn when an issue matures or is called or refinanced
and, at Fitch's discretion, when an issuer fails to furnish proper and
timely information.
FitchAlert Ratings are placed on FitchAlert to notify investors of an occurrence that
is likely to result in a rating change and the likely direction of such
change. These are designated as "Positive," indicating a potential upgrade,
"Negative," for potential downgrade, or "Evolving,"where ratings may be
raised or lowered. FitchAlert is relatively short-term, and should be
resolved within 12 months.
Ratings Outlook An outlook is used to describe the most likely direction of any rating
change over the intermediate term. It is described as "Positive" or
"Negative." The absence of a designation indicates a stable outlook.
</TABLE>
SPECULATIVE GRADE BOND RATINGS: Fitch speculative grade bond ratings provide
a guide to investors in determining the credit risk associated with a particular
security. The ratings ("BB" to "C") represent Fitch's assessment of the
likelihood of timely payment of principal and interest in accordance with the
terms of obligation for bond issues not in default. For defaulted bonds, the
rating ("DDD" to "D") is an assessment of the ultimate recovery value through
reorganization or liquidation.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and any guarantor,
as well as the economic and political environment that might affect the issuer's
future financial strength.
Bonds that have the rating are of similar but not necessarily identical
credit quality since rating categories cannot fully reflect the differences in
degrees of credit risk.
<TABLE>
<S> <C>
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 Bonds are in default on interest and/or principal payments. Such bonds are
DD and D 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 these bonds, and "D"
represents the lowest potential for recovery.
Plus(+) or Plus and minus signs are used with a rating symbol to indicate the relative
Minus(-) position of a credit within the rating category. Plus and minus signs, however,
are not used in the "DDD," "DD," or "D" categories.
</TABLE>
59
<PAGE>
SHORT-TERM RATINGS
Fitch's short-term ratings apply to debt obligations that are payable on
demand or have original maturities of up to three years, including commercial
paper, certificates of deposit, medium-term notes, and municipal and investment
notes.
The short-term rating places greater emphasis than a long-term rating on the
existence of liquidity necessary to meet the issuer's obligations in a timely
manner.
Fitch short-term ratings are as follows:
<TABLE>
<S> <C>
F-1+ Exceptionally Strong Credit Quality. Issues assigned this rating are regarded as
having the strongest degree of assurance for timely payment.
F-1 Very Strong Credit Quality. Issues assigned this rating reflect an assurance of
timely payment only slightly less in degree than issues rated "F-1+."
F-2 Good Credit Quality. Issues assigned this rating have a satisfactory degree of
assurance for timely payment, but the margin of safety is not as great as for issues
assigned "F-1+" and "F-1" ratings.
F-3 Fair Credit Quality. Issues assigned this rating have characteristics suggesting that
the degree of assurance for timely payment is adequate; however, near-term adverse
changes could cause these securities to be rated below in investment grade.
F-S Weak Credit Quality. Issues assigned this rating have characteristics suggesting a
minimal degree of assurance for timely payment and are vulnerable to near-term
adverse changes in financial and economic conditions.
D Default. Issues assigned this rating are in actual or imminent payment default.
LOC The symbol "LOC" indicates that the rating is based on a letter of credit issued by a
commercial bank.
</TABLE>
60
