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PAINEWEBBER UTILITY INCOME FUND
1285 AVENUE OF THE AMERICAS
NEW YORK, NEW YORK 10019
STATEMENT OF ADDITIONAL INFORMATION
PaineWebber Utility Income Fund ("Fund") is a diversified series of a
professionally managed open-end investment company organized as a Massachusetts
business trust ("Trust"). The Fund seeks to provide current income and capital
appreciation and invests primarily in income-producing equity and debt
securities of domestic and foreign companies in the utility industries.
Mitchell Hutchins Asset Management Inc. ("Mitchell Hutchins"), a wholly owned
subsidiary of PaineWebber Incorporated ("PaineWebber"), is the investment
adviser, administrator and distributor of the Fund. As distributor for the
Fund, Mitchell Hutchins has appointed PaineWebber to serve as the exclusive
dealer for the sale of Fund shares. This Statement of Additional Information is
not a prospectus and should be read only in conjunction with the Fund's current
Prospectus, dated April 1, 1995. A copy of the Prospectus may be obtained by
calling any PaineWebber investment executive or correspondent firm or by
calling toll-free 1-800-647-1568. This Statement of Additional Information is
dated April 1, 1995.
INVESTMENT POLICIES AND RESTRICTIONS
The following supplements the information contained in the Prospectus
concerning the Fund's investment policies and limitations.
UTILITY INDUSTRIES--DESCRIPTION AND RISK FACTORS. Utility companies in the
United States and in foreign countries are generally subject to regulation. In
the United States, most utility companies are regulated by state and/or federal
authorities. Such regulation is intended to ensure appropriate standards of
service and adequate capacity to meet public demand. Prices are also regulated,
with the intention of protecting the public while ensuring that the rate of
return earned by utility companies is sufficient to allow them to attract
capital in order to grow and continue to provide appropriate services. There
can be no assurance that such pricing policies or rates of return will continue
in the future.
The nature of regulation of utility industries is evolving both in the United
States and in foreign countries. Changes in regulation in the United States
increasingly allow utility companies to provide services and products outside
their traditional geographic areas and lines of business, creating new areas of
competition within the industries. Although certain companies may develop more
profitable opportunities, others may be forced to defend their core businesses
and may be less profitable.
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The regulation of foreign utility companies may or may not be comparable to
that in the United States. Foreign regulatory systems vary from country to
country, and may evolve in ways different from regulation in the United States.
The Fund's investment policies are designed to enable it to capitalize on
evolving investment opportunities throughout the world. For example, the rapid
growth of certain foreign economies will necessitate expansion of capacity in
the utility industries in those countries. Although many foreign utility
companies currently are government-owned, thereby limiting current investment
opportunities for the Fund, Mitchell Hutchins believes that, in order to
attract significant capital for growth, foreign governments may seek global
investors through the privatization of their utility industries. Privatization,
which refers to the trend toward investor ownership of assets rather than
government ownership, is expected to occur in newer, faster-growing economies
and also in more mature economies. In addition, the economic unification of
European markets may improve economic growth, reduce costs and increase
competition in Europe, which will result in opportunities for investment by the
Fund in European utility industries. Of course, there is no assurance that such
favorable developments will occur or that investment opportunities in foreign
markets for the Fund will increase.
The revenues of domestic and foreign utility companies generally reflect the
economic growth and developments in the geographic areas in which they do
business. Mitchell Hutchins takes into account anticipated economic growth
rates and other economic developments when selecting securities of utility
companies. Further descriptions of specific segments within the global utility
industries are set forth below.
Electric. The electric utility industry consists of companies that are
engaged principally in the generation, transmission and sale of electric
energy, although many also provide other energy-related services. Domestic
electric utility companies in general recently have been favorably affected by
lower fuel and financing costs and the full or near completion of major
construction programs. In addition, many of these companies recently have
generated cash flows in excess of current operating expenses and construction
expenditures, permitting some degree of diversification into unregulated
businesses. Some electric utilities have also taken advantage of the right to
sell power outside of their traditional geographic areas. Electric utility
companies have historically been subject to the risks associated with increases
in fuel and other operating costs, high interest costs on borrowings needed for
capital construction programs, costs associated with compliance with
environmental, nuclear facility and other safety regulations and changes in the
regulatory climate. For example, in the United States, the construction and
operation of nuclear power facilities is subject to increased scrutiny by, and
evolving regulations of, the Nuclear Regulatory Commission. Increased scrutiny
might result in higher operating costs and higher capital expenditures, with
the risk that regulators may disallow inclusion of these costs in rate
authorizations.
Telecommunications. The telephone communications industry is a distinct
utility industry segment that is subject to different risks and opportunities.
Companies that provide telephone services and access to the telephone networks
comprise the largest portion of this segment. The telephone industry is large
and highly concentrated. Telephone companies in the United States are
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still experiencing the effects of the break-up of American Telephone &
Telegraph Company, which occurred in 1984. Since that date the number of local
and long-distance companies and the competition among such companies has
increased. In addition, since 1984, companies engaged in telephone
communication services have expanded their nonregulated activities into other
businesses, including cellular telephone services, data processing, equipment
retailing and software services. This expansion has provided significant
opportunities for certain telephone companies to increase their earnings and
dividends at faster rates than have been allowed in traditional regulated
businesses. Increasing competition and other structural changes, however, could
adversely affect the profitability of such utilities.
Gas. Gas transmission companies and gas distribution companies are also
undergoing significant changes. In the United States, interstate transmission
companies are regulated by the Federal Energy Regulatory Commission, which is
reducing its regulation of the industry. Many companies have diversified into
oil and gas exploration and development, making returns more sensitive to
energy prices. In the recent decade, gas utility companies have been adversely
affected by disruption in the oil industry and have also been affected by
increased concentration and competition.
Water. Water supply utilities are companies that collect, purify, distribute
and sell water. In the United States and around the world, the industry is
highly fragmented, because most of the supplies are owned by local authorities.
Companies in this industry are generally mature and are experiencing little or
no per capita volume growth. Mitchell Hutchins believes that favorable
investment opportunities may result from consolidation within this industry.
There can be no assurance that the positive developments noted above,
including those relating to business growth and changing regulation, will occur
or that risk factors other than those noted above will not develop in the
future.
SPECIAL CONSIDERATIONS RELATING TO FOREIGN SECURITIES. Many of the foreign
securities held by the Fund are not registered with the Securities and Exchange
Commission ("SEC"), nor are the issuers thereof subject to its reporting
requirements. Accordingly, there may be less publicly available information
concerning foreign issuers of securities held by the Fund than is available
concerning U.S. companies. Foreign companies are not generally subject to
uniform accounting, auditing and financial reporting standards or to other
regulatory requirements comparable to those applicable to U.S. companies.
In addition to purchasing securities of foreign issuers in foreign markets,
the Fund may invest in American Depository Receipts ("ADRs"), European
Depository Receipts ("EDRs") or other securities convertible into securities of
corporations based in foreign countries. These securities may not necessarily
be denominated in the same currency as the securities into which they may be
converted. Generally, ADRs, in registered form, are denominated in U.S. dollars
and are designed for use in the U.S. securities markets and EDRs, in bearer
form, may be denominated in other currencies and are designed for use in
European securities markets. ADRs are receipts typically issued by a U.S. bank
or trust company evidencing ownership of the underlying securities. EDRs are
European receipts evidencing a similar arrangement. For purposes of the Fund's
investment
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policies, ADRs and EDRs are deemed to have the same classification as the
underlying securities they represent. Thus, an ADR or EDR evidencing ownership
of common stock will be treated as common stock.
The Fund anticipates that its brokerage transactions involving securities of
companies headquartered in countries other than the United States will be
conducted primarily on the principal exchanges of such countries. Foreign
securities trading practices, including those involving securities settlement
where Fund assets may be released prior to receipt of payment, may expose the
Fund to increased risk in the event of a failed trade or the insolvency of a
foreign broker-dealer. Transactions on foreign exchanges are usually subject to
fixed commissions that are generally higher than negotiated commissions on U.S.
transactions, although the Fund will endeavor to achieve the best net results
in effecting its portfolio transactions. There is generally less government
supervision and regulation of exchanges and brokers in foreign countries than
in the United States.
Investments in foreign government debt securities involve special risks. The
issuer of the debt or the governmental authorities that control the repayment
of the debt may be unable or unwilling to pay interest or repay principal when
due in accordance with the terms of such debt, and the Fund may have limited
legal recourse in the event of default. Foreign government debt securities
differ from debt obligations issued by private entities in that, generally,
remedies for defaults must be pursued in the courts of the defaulting party.
Legal recourse is therefore somewhat limited. Political conditions, especially
a sovereign entity's willingness to meet the terms of its debt obligations, are
of considerable significance. Also there can be no assurance that the holders
of commercial bank loans to the same sovereign entity may not contest payments
to the holders of foreign government debt securities in the event of default
under commercial bank loan agreements.
Investment income on certain foreign securities in which the Fund may invest
may be subject to foreign withholding or other taxes that could reduce the
return on these securities. Tax treaties between the United States and foreign
countries, however, may reduce or eliminate the amount of foreign taxes to
which the Fund would be subject.
FOREIGN CURRENCY TRANSACTIONS. Although the Fund values its assets daily in
U.S. dollars, it does not intend to convert its holdings of foreign currencies
to U.S. dollars on a daily basis. The Fund's foreign currencies generally will
be held as "foreign currency call accounts" at foreign branches of foreign or
domestic banks. These accounts bear interest at negotiated rates and are
payable upon relatively short demand periods. If a bank became insolvent, the
Fund could suffer a loss of some or all of the amounts deposited. The Fund may
convert foreign currency to U.S. dollars from time to time. Although foreign
exchange dealers generally do not charge a stated commission or fee for
conversion, the prices posted generally include a "spread," which is the
difference between the prices at which the dealers are buying and selling
foreign currencies.
RATINGS OF DEBT OBLIGATIONS. Moody's Investors Service, Inc. ("Moody's"),
Standard & Poor's Ratings Group ("S&P") and other nationally recognized or
foreign statistical rating organizations ("SROs") are private organizations
that provide ratings of the credit quality of debt obligations. A description
of the ratings assigned to corporate debt obligations by Moody's and S&P is
included in the Appendix to this Statement of Additional Information. The Fund
may use these ratings in determining whether to purchase, sell or hold a
security. It should be emphasized, however, that
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ratings are general and are not absolute standards of quality. Consequently,
securities with the same maturity, interest rate and rating may have different
market prices. Credit ratings attempt to evaluate the safety of principal and
interest payments and do not evaluate the risks of fluctuations in market value
or the risks of changes in foreign currency exchange rates. The rating assigned
to a security by an SRO does not reflect an assessment of the volatility of the
security's market value or of the liquidity of an investment in the security.
Also, SROs may fail to make timely changes in credit ratings in response to
subsequent events, so that an issuer's current financial condition may be
better or worse than the rating indicates. Subsequent to its purchase by the
Fund, an issue of debt obligations may cease to be rated or its rating may be
reduced below the minimum rating required for purchase by the Fund. Mitchell
Hutchins will consider such an event in determining whether the Fund should
continue to hold the obligation but is not required to dispose of it.
As noted in the Prospectus, the Fund is authorized to invest up to 5% of its
total assets in non-investment grade debt securities--that is, debt securities
that are not rated at the time of purchase within one of the four highest
grades assigned by S&P or Moody's, comparably rated by another SRO or
determined by Mitchell Hutchins to be of comparable quality. Lower rated debt
securities generally offer a higher current yield than that available for
investment grade issues; however, they involve higher risks in that they are
especially subject to adverse changes in general economic conditions and in the
industries in which the issuers are engaged, to changes in the financial
condition of the issuers and to price fluctuations in response to changes in
interest rates. During periods of economic downturn or rising interest rates,
highly leveraged issuers may experience financial stress which could adversely
affect their ability to make payments of interest and principal and increase
the possibility of default. In addition, such issuers may not have more
traditional methods of financing available to them and may be unable to repay
debt at maturity by refinancing. The risk of loss due to default by such
issuers is significantly greater because such securities frequently are
unsecured and subordinated to the prior payment of senior indebtedness.
The market for lower rated debt securities has expanded rapidly in recent
years, and its growth paralleled a long economic expansion. In the past, the
prices of many lower rated debt securities declined substantially, reflecting
an expectation that many issuers of such securities might experience financial
difficulties. As a result, the yields on lower rated debt securities rose
dramatically. However, such higher yields did not reflect the value of the
income stream that holders of such securities expected, but rather the risk
that holders of such securities could lose a substantial portion of their value
as a result of the issuers' financial restructuring or default. There can be no
assurance that such declines will not recur. The market for lower-rated debt
issues generally is thinner and less active than that for higher quality
securities, which may limit the Fund's ability to sell such securities at fair
value in response to changes in the economy or financial markets. Adverse
publicity and investor perceptions, whether or not based on fundamental
analysis, may also decrease the values and liquidity of lower rated securities,
especially in a thinly traded market.
ILLIQUID SECURITIES. The Fund may invest up to 10% of its net assets in
illiquid securities. The term "illiquid securities" for this purpose means
securities that cannot be disposed of within seven days in the ordinary course
of business at approximately the amount at which the Fund has valued the
securities and includes, among other things, purchased over-the-counter ("OTC")
options,
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repurchase agreements maturing in more than seven days and restricted
securities other than those securities Mitchell Hutchins has determined are
liquid pursuant to guidelines established by the Trust's board of trustees. The
assets used as cover for OTC options written by the Fund will be considered
illiquid unless the OTC options are sold to qualified dealers who agree that
the Fund may repurchase any OTC option it writes for a maximum price to be
calculated by a formula set forth in the option agreement. The cover for an OTC
option written subject to this procedure would be considered illiquid only to
the extent that the maximum repurchase price under the formula exceeds the
intrinsic value of the option. Illiquid restricted securities may be sold only
in privately negotiated transactions or in public offerings with respect to
which a registration statement is in effect under the Securities Act of 1933
("1933 Act"). Illiquid securities include those that are subject to
restrictions contained in the securities laws of other countries. However,
securities that are freely marketable in the country where they are principally
traded, but would not be freely marketable in the United States, will not be
considered illiquid. Where registration is required, the Fund may be obligated
to pay all or part of the registration expenses, and a considerable period may
elapse between the time of the decision to sell and the time the Fund may be
permitted to sell a security under an effective registration statement. If,
during such a period, adverse market conditions were to develop, the Fund might
obtain a less favorable price than prevailed when it decided to sell.
Not all restricted securities are illiquid. In recent years, a large
institutional market has developed for certain securities that are not
registered under the 1933 Act, including private placements, repurchase
agreements, commercial paper, foreign securities and corporate bonds and notes.
These instruments are often restricted securities because the securities are
sold in transactions not requiring registration. Institutional investors
generally will not seek to sell these instruments to the general public, but
instead will often depend either on an efficient institutional market in which
such unregistered securities can be readily resold or on an issuer's ability to
honor a demand for repayment. Therefore, the fact that there are contractual or
legal restrictions on resale to the general public or certain institutions is
not dispositive of the liquidity of such investments.
Rule 144A under the 1933 Act establishes a "safe harbor" from the
registration requirements of the 1933 Act for resales of certain securities to
qualified institutional buyers. Institutional markets for restricted securities
have developed as a result of Rule 144A, providing both readily ascertainable
values for restricted securities and the ability to liquidate an investment to
satisfy share redemption orders. Such markets include automated systems for the
trading, clearance and settlement of unregistered securities of domestic and
foreign issuers, such as the PORTAL System sponsored by the National
Association of Securities Dealers, Inc. An insufficient number of qualified
institutional buyers interested in purchasing Rule 144A-eligible restricted
securities held by the Fund, however, could affect adversely the marketability
of such portfolio securities, and the Fund might be unable to dispose of such
securities promptly or at favorable prices.
The Trust's board of trustees has delegated the function of making day-to-day
determinations of liquidity to Mitchell Hutchins, pursuant to guidelines
approved by the board. Mitchell Hutchins takes into account a number of factors
in reaching liquidity decisions, including (1) the frequency of trades for the
security, (2) the number of dealers that make quotes for the security, (3) the
number of dealers that have undertaken to make a market in the security, (4)
the number of other potential
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purchasers and (5) the nature of the security and how trading is effected
(e.g., the time needed to sell the security, how bids are solicited and the
mechanics of transfer). Mitchell Hutchins monitors the liquidity of restricted
securities in the Fund's portfolio and reports periodically on such decisions
to the board of trustees.
REPURCHASE AGREEMENTS. Repurchase agreements are transactions in which the
Fund purchases securities from a bank or recognized securities dealer and
simultaneously commits to resell the securities to the bank or dealer at an
agreed-upon date and price reflecting a market rate of interest unrelated to
the coupon rate or maturity of the purchased securities. The Fund maintains
custody of the underlying securities prior to their repurchase; thus, the
obligation of the bank or dealer to pay the repurchase price on the date agreed
to is, in effect, secured by such securities. If the value of such securities
is less than the repurchase price, plus any agreed-upon additional amount, the
other party to the agreement must provide additional collateral so that at all
times the collateral is at least equal to the repurchase price, plus any
agreed-upon additional amount. The difference between the total amount to be
received upon repurchase of the securities and the price that was paid by the
Fund upon their acquisition is accrued as interest and included in the Fund's
net investment income.
Repurchase agreements carry certain risks not associated with direct
investments in securities, including possible declines in the market value of
the underlying securities and delays and costs to the Fund if the other party
to a repurchase agreement becomes insolvent. The Fund intends to enter into
repurchase agreements only with banks and dealers in transactions believed by
Mitchell Hutchins to present minimum credit risks in accordance with guidelines
established by the Trust's board of trustees. Mitchell Hutchins will review and
monitor the creditworthiness of those institutions under the board's general
supervision.
REVERSE REPURCHASE AGREEMENTS. The Fund may enter into reverse repurchase
agreements with banks and securities dealers up to an aggregate value of not
more than 5% of its net assets. Such agreements involve the sale of securities
held by the Fund subject to its agreement to repurchase the securities at an
agreed-upon date and price reflecting a market rate of interest. Such
agreements are considered to be borrowings and may be entered into only for
temporary or emergency purposes. While a reverse repurchase agreement is
outstanding, the Fund's custodian segregates assets to cover the amount of the
Fund's obligations under the reverse repurchase agreement. See "Investment
Policies and Restrictions--Segregated Accounts."
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. As stated in the Prospectus, the
Fund may purchase securities on a "when-issued" or delayed delivery basis. A
security purchased on a when-issued or delayed delivery basis is recorded as an
asset on the commitment date and is subject to changes in market value
generally based upon changes in the level of interest rates. Thus, fluctuation
in the value of the security from the time of the commitment date will affect
the Fund's net asset value. When the Fund agrees to purchase securities on a
when-issued basis, its custodian segregates assets to cover the amount of the
commitment. See "Investment Policies and Restrictions--Segregated Accounts."
The Fund purchases when-issued securities only with the intention of taking
delivery, but may sell the right to acquire the security prior to delivery if
Mitchell Hutchins deems it advantageous to do so, which may result in capital
gain or loss to the Fund.
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CONVERTIBLE SECURITIES. As stated in the Prospectus, the Fund may invest in
convertible securities. A convertible security is a bond, debenture, note,
preferred stock or other security that may be converted into or exchanged for a
prescribed amount of common stock of the same or a different issuer within a
particular period of time at a specified price or formula. A convertible
security entitles the holder to receive interest paid or accrued on debt or
dividends paid on preferred stock until the convertible security matures or is
redeemed, converted or exchanged. Convertible securities have unique investment
characteristics in that they generally (1) have higher yields than common
stock, but lower yields than comparable non-convertible securities, (2) are
less subject to fluctuation in value than the underlying stock because they
have fixed income characteristics, and (3) provide the potential for capital
appreciation if the market price of the underlying common stock increases.
While no securities investment is without some risk, investments in convertible
securities generally entail less risk than the issuer's common stock, although
the extent to which such risk is reduced depends in large measure upon the
degree to which the convertible security sells above its value as a fixed
income security.
Before conversion, convertible securities have characteristics similar to
nonconvertible debt securities in that they ordinarily provide a stable stream
of income with generally higher yields than those of common stocks of the same
or similar issuers. Convertible securities rank senior to common stock in a
corporation's capital structure but are usually subordinated to comparable
nonconvertible securities. The value of a convertible security is a function of
its "investment value" (determined by its yield in comparison with the yields
of other securities of comparable maturity and quality that do not have a
conversion privilege) and its "conversion value" (the security's worth, at
market value, if converted into the underlying common stock). The investment
value of a convertible security is influenced by changes in interest rates,
with investment value declining as interest rates increase and increasing as
interest rates decline. The credit standing of the issuer and other factors
also may have an effect on the convertible security's investment value. The
conversion value of a convertible security is determined by the market price of
the underlying common stock. If the conversion value is low relative to the
investment value, the price of the convertible security is governed principally
by its investment value, and generally the conversion value decreases as the
convertible security approaches maturity. To the extent the market price of the
underlying common stock approaches or exceeds the conversion price, the price
of the convertible security will be increasingly influenced by its conversion
value. In addition, a convertible security generally will sell at a premium
over its conversion value determined by the extent to which investors place
value on the right to acquire the underlying common stock while holding a fixed
income security.
LENDING OF PORTFOLIO SECURITIES. Although the Fund has no intention of doing
so during the coming year, it is authorized to lend up to 10% of the total
value of its portfolio securities to broker-dealers or institutional investors
that Mitchell Hutchins deems qualified, but only when the borrower maintains
with the Fund's custodian bank collateral either in cash or money market
instruments, marked to market daily, in an amount at least equal to the market
value of the securities loaned, plus accrued interest and dividends. In
determining whether to lend securities to a particular broker-dealer or
institutional investor, Mitchell Hutchins will consider, and during the period
of the loan will monitor, all relevant facts and circumstances, including the
creditworthiness of the borrower. The Fund will retain authority to terminate
any loans at any time. The Fund may pay reasonable administrative and custodial
fees in connection with a loan and may pay a negotiated
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portion of the interest earned on the cash or money market instruments held as
collateral to the borrower or placing broker. The Fund will receive reasonable
interest on the loan or a flat fee from the borrower and amounts equivalent to
any dividends, interest or other distributions on the securities loaned. The
Fund will regain record ownership of loaned securities to exercise beneficial
rights, such as voting and subscription rights and rights to dividends,
interest or other distributions, when regaining such rights is considered to be
in the Fund's interest.
SEGREGATED ACCOUNTS. When the Fund enters into certain transactions that
involve obligations to make future payments to third parties, including reverse
repurchase agreements or the purchase of securities on a when-issued or delayed
delivery basis, the Fund will maintain with an approved custodian in a
segregated account cash, U.S. government securities or other liquid high-grade
debt securities, marked to market daily, in an amount at least equal to the
Fund's obligation or commitment under such transactions. As described below
under "Hedging and Related Income Strategies," segregated accounts may also be
required in connection with certain transactions involving options or futures
contracts, interest rate protection transactions or forward currency contracts.
INVESTMENT LIMITATIONS. The Fund may not:
(1) issue senior securities or borrow money, except from banks or through
reverse repurchase agreements for emergency or temporary purposes, and then in
an aggregate amount not in excess of 10% of the value of the Fund's total
assets at the time of such borrowing, provided that the Fund will not purchase
securities while borrowings (including reverse repurchase agreements) in excess
of 5% of the value of the Fund's total assets are outstanding;
(2) purchase securities of any one issuer if as a result more than 5% of the
Fund's total assets would be invested in such issuer or the Fund would own or
hold 10% of the outstanding securities of that issuer, except that up to 25% of
the Fund's total assets may be invested without regard to this limitation and
provided that this limitation does not apply to securities issued or guaranteed
by the U.S. government, its agencies and instrumentalities;
(3) make an investment in any one industry if the investment would cause the
aggregate value of the Fund's investments in such industry to exceed 25% of the
Fund's total assets, except that U.S. government securities are not subject to
this limitation and except that the Fund, under normal circumstances, will
invest 25% or more of its total assets in utility industries as a group
(utility industries for this purpose consist of companies primarily engaged in
the ownership or operation of facilities used in the generation, transmission
or distribution of electricity, telecommunications, gas or water);
(4) purchase securities on margin, except for short-term credits necessary
for clearance of portfolio transactions, and except that the Fund may make
margin deposits in connection with its use of options, futures contracts and
options on futures contracts;
(5) engage in the business of underwriting securities of other issuers,
except to the extent that, in connection with the disposition of portfolio
securities, the Fund may be deemed an underwriter under federal securities laws
and except that the Fund may write options;
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(6) make short sales of securities or maintain a short position, except that
the Fund may (a) make short sales and maintain short positions in connection
with its use of options, futures contracts, options on futures contracts and
forward contracts and (b) sell short "against the box";
(7) Purchase or sell real estate (including real estate limited partnership
interests), provided that the Fund may invest in securities secured by real
estate or interests therein or issued by companies which invest in real estate
or interests therein;
(8) purchase or sell commodities or commodity contracts, except that the Fund
may purchase and sell financial futures contracts, such as interest rate, stock
index, bond index and foreign currency futures contracts and options thereon,
may engage in transactions in foreign currencies and may purchase or sell
options on foreign currencies;
(9) invest in oil, gas or mineral-related programs or leases; or
(10) make loans, except through loans of portfolio securities and except
through repurchase agreements, provided that for purposes of this restriction
the acquisition of publicly distributed bonds, debentures or other corporate
debt securities and investment in government obligations, short-term commercial
paper, certificates of deposit and bankers' acceptances shall not be deemed to
be the making of a loan.
The foregoing fundamental investment limitations cannot be changed without
the affirmative vote of the lesser of (1) more than 50% of the outstanding
shares of the Fund or (2) 67% or more of the shares present at a shareholders'
meeting if more than 50% of the outstanding shares are represented at the
meeting in person or by proxy. If a percentage restriction is adhered to at the
time of an investment or transaction, a later increase or decrease in
percentage resulting from a change in values of portfolio securities or amount
of total assets will not be considered a violation of any of the foregoing
limitations.
The following investment restrictions are non-fundamental and may be changed
by the vote of the Trust's board of trustees without shareholder approval:
(1) the Fund will not purchase or retain the securities of any issuer if, to
the knowledge of the Fund's management, the officers and trustees of the Trust
and the officers and directors of Mitchell Hutchins (each owning beneficially
more than 0.5% of the outstanding securities of the issuer) own in the
aggregate more than 5% of the securities of the issuer;
(2) the Fund will not invest more than 10% of its net assets in illiquid
securities, a term which means securities that cannot be disposed of within
seven days in the ordinary course of business at approximately the amount at
which the Fund has valued the securities and includes, among other things,
repurchase agreements maturing in more than seven days;
(3) the Fund will not purchase any security if as a result the Fund would
have more than 5% of its total assets invested in securities of companies which
together with any predecessors have been in continuous operation for less than
three years;
(4) the Fund will not purchase securities of other open-end investment
companies, except in connection with a merger, consolidation, reorganization or
acquisition of assets;
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(5) the Fund's investments in warrants, valued at the lower of cost or
market, may not exceed 5% of the value of its net assets, which amount may
include warrants that are not listed on the New York Stock Exchange Inc.
("NYSE") or the American Stock Exchange, Inc., provided that such warrants,
valued at the lower of cost or market, do not exceed 2% of the Fund's net
assets, and further provided that this restriction does not apply to warrants
attached to, or sold as a unit with, other securities. For purposes of this
restriction, the term "warrants" does not include options on debt securities,
bond indices, foreign currencies or futures contracts; and
(6) the Fund will not invest more than 35% of its total assets in debt
securities rated Ba or lower by Moody's or BB or lower by S&P, comparably rated
by another SRO or determined by Mitchell Hutchins to be of comparable quality.
This non-fundamental policy (6) can be changed only upon 30 days' advance
notice to shareholders.
HEDGING AND RELATED INCOME STRATEGIES
GENERAL DESCRIPTION OF HEDGING STRATEGIES. As discussed in the Prospectus,
Mitchell Hutchins may use a variety of financial instruments ("Hedging
Instruments"), including certain options, futures contracts, options on futures
contracts and forward currency contracts, to attempt to hedge the Fund's
portfolio. The Fund also may use options to attempt to enhance income and may
use stock index futures contracts, bond index futures contracts, interest rate
futures contracts and foreign currency futures contracts (collectively,
"futures contracts" or "futures") and options on futures contracts in other
circumstances permitted by the Commodity Futures Trading Commission ("CFTC").
The particular Hedging Instruments used by the Fund are described in the
Appendix to the Prospectus.
Hedging strategies can be broadly categorized as "short hedges" and "long
hedges." A short hedge is a purchase or sale of a Hedging Instrument intended
partially or fully to offset potential declines in the value of one or more
investments held in the Fund's portfolio. Thus, in a short hedge the Fund takes
a position in a Hedging Instrument whose price is expected to move in the
opposite direction of the price of the investment being hedged. For example,
the Fund might purchase a put option on a security to hedge against a potential
decline in the value of that security. If the price of the security declined
below the exercise price of the put, the Fund could exercise the put and thus
limit its loss below the exercise price to the premium paid plus transaction
costs. In the alternative, because the value of the put option can be expected
to increase as the value of the underlying security declines, the Fund might be
able to close out the put option and realize a gain to offset the decline in
the value of the security.
Conversely, a long hedge is a purchase or sale of a Hedging Instrument
intended partially or fully to offset potential increases in the acquisition
cost of one or more investments that the Fund intends to acquire. Thus, in a
long hedge the Fund takes a position in a Hedging Instrument whose price is
expected to move in the same direction as the price of the prospective
investment being hedged. For example, the Fund might purchase a call option on
a security it intends to purchase in order to hedge against an increase in the
cost of the security. If the price of the security increased above the exercise
price of the call, the Fund could exercise the call and thus limit its
acquisition
11
<PAGE>
cost to the exercise price plus the premium paid and transaction costs.
Alternatively, the Fund might be able to offset the price increase by closing
out an appreciated call option and realizing a gain.
The Fund may purchase and write (sell) covered straddles on securities, stock
indices, bond indices or currencies. A long straddle is a combination of a call
and a put option purchased on the same security or on the same futures
contract, where the exercise price of the put is less than or equal to the
exercise price of the call. The Fund might enter into a long straddle when
Mitchell Hutchins believes that it is likely that stock prices, interest rates
or currency exchange rates will be more volatile during the term of the options
than the option pricing implies. A short straddle is a combination of a call
and a put written on the same security where the exercise price of the put is
less than or equal to the exercise price of the call. The Fund might enter into
a short straddle when Mitchell Hutchins believes that it is unlikely that stock
prices, interest rates or currency exchange rates will be as volatile during
the term of the options as the option pricing implies.
Hedging Instruments on securities generally are used to hedge against price
movements in one or more particular securities positions that the Fund owns or
intends to acquire. Hedging Instruments on stock indices, in contrast,
generally are used to hedge against price movements in broad equity market
sectors in which the Fund has invested or expects to invest. Hedging
Instruments on debt securities may be used to hedge either individual
securities or broad fixed income market sectors.
The use of Hedging Instruments is subject to applicable regulations of the
SEC, the several options and futures exchanges upon which they are traded, the
CFTC and various state regulatory authorities. In addition, the Fund's ability
to use Hedging Instruments will be limited by tax considerations. See "Taxes."
In addition to the products, strategies and risks described below and in the
Prospectus, Mitchell Hutchins expects to discover additional opportunities in
connection with options, futures contracts, forward currency contracts and
other hedging techniques. These new opportunities may become available as
Mitchell Hutchins develops new techniques, as regulatory authorities broaden
the range of permitted transactions and as new options, futures contracts,
forward currency contracts or other techniques are developed. Mitchell Hutchins
may utilize these opportunities to the extent that they are consistent with the
Fund's investment objective and permitted by the Fund's investment limitations
and applicable regulatory authorities. The Fund's Prospectus or Statement of
Additional Information will be supplemented to the extent that new products or
techniques involve materially different risks than those described below or in
the Prospectus.
SPECIAL RISKS OF HEDGING STRATEGIES. The use of Hedging Instruments involves
special considerations and risks, as described below. Risks pertaining to
particular Hedging Instruments are described in the sections that follow.
(1) Successful use of most Hedging Instruments depends upon Mitchell
Hutchins' ability to predict movements of the overall securities, currency and
interest rate markets, which requires different skills than predicting changes
in the prices of individual securities. While Mitchell Hutchins is experienced
in the use of Hedging Instruments, there can be no assurance that any
particular hedging strategy adopted will succeed.
12
<PAGE>
(2) There might be imperfect correlation, or even no correlation, between
price movements of a Hedging Instrument and price movements of the investments
being hedged. For example, if the value of a Hedging Instrument used in a short
hedge increased by less than the decline in value of the hedged investment, the
hedge would not be fully successful. Such a lack of correlation might occur due
to factors unrelated to the value of the investments being hedged, such as
speculative or other pressures on the markets in which Hedging Instruments are
traded.
The effectiveness of hedges using Hedging Instruments on indices will depend
on the degree of correlation between price movements in the index and price
movements in the securities being hedged.
(3) Hedging strategies, if successful, can reduce risk of loss by wholly or
partially offsetting the negative effect of unfavorable price movements in the
investments being hedged. However, hedging strategies can also reduce
opportunity for gain by offsetting the positive effect of favorable price
movements in the hedged investments. For example, if the Fund entered in a
short hedge because Mitchell Hutchins projected a decline in the price of a
security in the Fund's portfolio, and the price of that security increased
instead, the gain from that increase might be wholly or partially offset by a
decline in the price of the Hedging Instrument. Moreover, if the price of the
Hedging Instrument declined by more than the increase in the price of the
security, the Fund could suffer a loss. In either such case, the Fund would
have been in a better position had it not hedged at all.
(4) As described below, the Fund might be required to maintain assets as
"cover," maintain segregated accounts or make margin payments when it takes
positions in Hedging Instruments
involving obligations to third parties (i.e., Hedging Instruments other than
purchased options). If the Fund were unable to close out its positions in such
Hedging Instruments, it might be required to continue to maintain such assets
or accounts or make such payments until the position expired or matured. These
requirements might impair the Fund's ability to sell a portfolio security or
make an investment at a time when it would otherwise be favorable to do so, or
require that the Fund sell a portfolio security at a disadvantageous time. The
Fund's ability to close out a position in a Hedging Instrument prior to
expiration or maturity depends on the existence of a liquid secondary market
or, in the absence of such a market, the ability and willingness of a contra
party to enter into a transaction closing out the position. Therefore, there is
no assurance that any hedging position can be closed out at a time and price
that is favorable to the Fund.
COVER FOR HEDGING STRATEGIES. Transactions using Hedging Instruments, other
than purchased options, expose the Fund to an obligation to another party. The
Fund will not enter into any such transactions unless it owns either (1) an
offsetting ("covered") position in securities, currencies or other options,
futures contracts or forward currency contracts or (2) cash and short-term
liquid debt securities, with a value sufficient at all times to cover its
potential obligations to the extent not covered as provided in (1) above. The
Fund will comply with SEC guidelines regarding cover for hedging transactions
and will, if the guidelines so require, set aside cash, U.S. government
securities or other liquid, high-grade debt securities in a segregated account
with its custodian in the prescribed amount.
Assets used as cover or held in a segregated account cannot be sold while the
position in the corresponding Hedging Instrument is open, unless they are
replaced with similar assets. As a result, the commitment of a large portion of
the Fund's assets to cover or segregated accounts could
13
<PAGE>
impede portfolio management or the Fund's ability to meet redemption requests
or other current obligations.
OPTIONS. The Fund may purchase put and call options, or write (sell) covered
put and call options, on equity and debt securities in which it is authorized
to invest, stock indices, bond indices and foreign currencies. The purchase of
call options serves as a long hedge, and the purchase of put options also
serves as a short hedge. Writing covered put options can enable the Fund to
enhance income by reason of the premiums paid by the purchasers of such
options. Writing covered put options serves as a limited long hedge because
increases in the value of the hedged investment would be offset to the extent
of the premium received for writing the option. However, if the market price of
the underlying security declines to less than the exercise price on the option,
minus the premium received, the Fund would expect to suffer a loss. Writing
covered call options also can enable the Fund to enhance income by reason of
the premiums paid for such options. In addition, writing covered call options
serves as a limited short hedge, because declines in the value of the hedged
investment would be offset to the extent of the premium received for writing
the option. However, if the security or currency appreciates to a price higher
than the exercise price of the call option, it can be expected that the option
will be exercised and the Fund will be obligated to sell the security or
currency at less than its market value. The securities or other assets used as
cover for OTC options written by the Fund would be considered illiquid to the
extent described under "Investment Policies and Restrictions--Illiquid
Securities."
The value of an option position will reflect, among other things, the current
market value of the underlying investment, the time remaining until expiration,
the relationship of the exercise price to the market price of the underlying
investment, the historical price volatility of the underlying investment and
general market conditions. Options normally have expiration dates of up to nine
months. Generally, the OTC debt and foreign currency options used by the Fund
are European-style options. This means that the option is only exercisable
immediately prior to its expiration. This is in contrast to American-style
options, which are exercisable at any time prior to the expiration date of the
option. Options that expire unexercised have no value.
The Fund may effectively terminate its right or obligation under an option by
entering into a closing transaction. For example, the Fund may terminate its
obligation under a call or put option that it had written by purchasing an
identical call or put option; this is known as a closing purchase transaction.
Conversely, the Fund may terminate a position in a put or call option it had
purchased by writing an identical put or call option; this is known as a
closing sale transaction. Closing transactions permit the Fund to realize
profits or limit losses on an option position prior to its exercise or
expiration.
The Fund may purchase or write both exchange-traded and OTC options. Exchange
markets for options on debt securities and foreign currencies exist but are
relatively new, and these instruments are primarily traded on the OTC market.
Exchange-traded options in the United States are issued by a clearing
organization affiliated with the exchange on which the option is listed which,
in effect, guarantees completion of every exchange-traded option transaction.
In contrast, OTC options are contracts between the Fund and its contra party
(usually a securities dealer or a bank) with no clearing organization
guarantee. Thus, when the Fund purchases or writes an OTC option,
14
<PAGE>
it relies on the contra party to make or take delivery of the underlying
investment upon exercise of the option. Failure by the contra party to do so
would result in the loss of any premium paid by the Fund as well as the loss of
any expected benefit of the transaction. The Fund will enter into OTC option
transactions only with contra parties that have a net worth of at least $20
million.
The Fund's ability to establish and close out positions in exchange-listed
options depends on the existence of a liquid market. The Fund intends to
purchase or write only those exchange-traded options for which there appears to
be a liquid secondary market. However, there can be no assurance that such a
market will exist at any particular time. Closing transactions can be made for
OTC options only by negotiating directly with the contra party, or by a
transaction in the secondary market if any such market exists. Although the
Fund will enter into OTC options only with contra parties that are expected to
be capable of entering into closing transactions with the Fund, there is no
assurance that the Fund will in fact be able to close out an OTC option
position at a favorable price prior to expiration. In the event of insolvency
of the contra party, the Fund might be unable to close out an OTC option
position at any time prior to its expiration.
If the Fund were unable to effect a closing transaction for an option it had
purchased, it would have to exercise the option to realize any profit. The
inability to enter into a closing purchase transaction for a covered call
option written by the Fund could cause material losses because the Fund would
be unable to sell the investment used as cover for the written option until the
option expires or is exercised.
The Fund may purchase and write put and call options on indices of equity or
debt securities in much the same manner as the more traditional options
discussed above, except the index options may serve as a hedge against overall
fluctuations in the equity or debt securities market (or market sectors) rather
than anticipated increases or decreases in the value of a particular security.
GUIDELINES FOR OPTIONS. The Fund's use of options is governed by the
following guidelines, which can be changed by the Trust's board of trustees
without shareholder vote:
(1)The Fund may purchase a put or call option, including any straddles or
spreads, only if the value of its premium, when aggregated with the premiums on
all other options held by the Fund, does not exceed 5% of the Fund's total
assets.
(2)The aggregate value of securities underlying put options written by the Fund
determined as of the date the put options are written will not exceed 50% of
the Fund's net assets.
(3)The aggregate premiums paid on all options (including options on securities,
foreign currencies and stock and bond indices and options on futures contracts)
purchased by the Fund that are held at any time will not exceed 20% of the
Fund's net assets.
FUTURES. The Fund may purchase and sell stock index futures contracts, bond
index futures contracts, interest rate futures contracts and foreign currency
futures contracts. The Fund may also purchase put and call options, and write
covered put and call options, on futures in which it is allowed to invest. The
purchase of futures or call options thereon can serve as a long hedge, and the
sale of futures or the purchase of put options thereon can serve as a short
hedge. Writing covered call options on futures contracts can serve as a limited
short hedge, using a strategy similar
15
<PAGE>
to that used for writing covered call options on securities or indices.
Similarly, writing covered put options on futures contracts can serve as a
limited long hedge.
The Fund may also write put options on a particular type of futures contract
while at the same time purchasing call options on the same futures contracts in
order synthetically to create a long futures contract position. Such options
would have the same strike prices and expiration dates. The Fund will engage in
this strategy only when it is more advantageous to the Fund than is purchasing
the futures contract.
No price is paid upon entering into a futures contract. Instead, at the
inception of a futures contract the Fund is required to deposit in a segregated
account with its custodian, in the name of the futures broker through whom the
transaction was effected, "initial margin" consisting of cash, U.S. government
securities or other liquid, high-grade debt securities, in an amount generally
equal to 10% or less of the contract value. Margin must also be deposited when
writing an option on a futures contract, in accordance with applicable exchange
rules. Unlike margin in securities transactions, initial margin on futures
contracts does not represent a borrowing, but rather is in the nature of a
performance bond or good-faith deposit that is returned to the Fund at the
termination of the transaction if all contractual obligations have been
satisfied. Under certain circumstances, such as periods of high volatility, the
Fund may be required by an exchange to increase the level of its initial margin
payment, and initial margin requirements might be increased generally in the
future by regulatory action.
Subsequent "variation margin" payments are made to and from the futures
broker daily as the value of the futures position varies, a process known as
"marking to market." Variation margin does not involve borrowing, but rather
represents a daily settlement of the Fund's obligations to or from a futures
broker. When the Fund purchases an option on a future, the premium paid plus
transaction costs is all that is at risk. In contrast, when the Fund purchases
or sells a futures contract or writes a put or call option thereon, it is
subject to daily variation margin calls that could be substantial in the event
of adverse price movements. If the Fund has insufficient cash to meet daily
variation margin requirements, it might need to sell securities at a time when
such sales are disadvantageous.
Holders and writers of futures positions and options on futures can enter
into offsetting closing transactions, similar to closing transactions on
options, by selling or purchasing, respectively, an instrument identical to the
instrument held or written. Positions in futures and options on futures may be
closed only on an exchange or board of trade that provides a secondary market.
The Fund intends to enter into futures transactions only on exchanges or boards
of trade where there appears to be a liquid secondary market. However, there
can be no assurance that such a market will exist for a particular contract at
a particular time.
Under certain circumstances, futures exchanges may establish daily limits on
the amount that the price of a future or related option can vary from the
previous day's settlement price; once that limit is reached, no trades may be
made that day at a price beyond the limit. Daily price limits do not limit
potential losses because prices could move to the daily limit for several
consecutive days with little or no trading, thereby preventing liquidation of
unfavorable positions.
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<PAGE>
If the Fund were unable to liquidate a futures or related options position
due to the absence of a liquid secondary market or the imposition of price
limits, it could incur substantial losses. The Fund would continue to be
subject to market risk with respect to the position. In addition, except in
the case of purchased options, the Fund would continue to be required to make
daily variation margin payments and might be required to maintain the position
being hedged by the future or option or to maintain cash or securities in a
segregated account.
Certain characteristics of the futures market might increase the risk that
movements in the prices of futures contracts or related options might not
correlate perfectly with movements in the prices of the investments being
hedged. For example, all participants in the futures and related options
markets are subject to daily variation margin calls and might be compelled to
liquidate futures or related options positions whose prices are moving
unfavorably to avoid being subject to further calls. These liquidations could
increase price volatility of the instruments and distort the normal price
relationship between the futures or options and the investments being hedged.
Also, because initial margin deposit requirements in the futures market are
less onerous than margin requirements in the securities markets, there might
be increased participation by speculators in the futures markets. This
participation also might cause temporary price distortions. In addition,
activities of large traders in both the futures and securities markets
involving arbitrage, "program trading" and other investment strategies might
result in temporary price distortions.
GUIDELINES FOR FUTURES AND RELATED OPTIONS. The Fund's use of futures and
related options is governed by the following guidelines, which can be changed
by the Trust's board of trustees without shareholder vote:
(1) To the extent the Fund enters into futures contracts, options on futures
positions and options on foreign currencies traded on a commodities exchange
that are not for bona fide hedging purposes (as defined by the CFTC), the
aggregate initial margin and premiums on those positions (excluding the amount
by which options are "in-the-money") may not exceed 5% of the Fund's net
assets.
(2) The aggregate premiums paid on all options (including options on
securities, foreign currencies and stock and bond indices and options on
futures contracts) purchased by the Fund that are held at any time will not
exceed 20% of the Fund's net assets.
(3) The aggregate margin deposits on all futures contracts and options
thereon held at any time by the Fund will not exceed 5% of the Fund's total
assets.
FOREIGN CURRENCY HEDGING STRATEGIES--SPECIAL CONSIDERATIONS. The Fund may
use options and futures on foreign currencies, as described above, and forward
currency contracts, as described below, to hedge against movements in the
values of the foreign currencies in which the Fund's securities are
denominated. Such currency hedges can protect against price movements in a
security that the Fund owns or intends to acquire that are attributable to
changes in the value of the currency in which it is denominated. Such hedges
do not, however, protect against price movements in the securities that are
attributable to other causes.
The Fund might seek to hedge against changes in the value of a particular
currency when no Hedging Instruments on that currency are available or such
Hedging Instruments are more expensive than certain other Hedging Instruments.
In such cases, the Fund may hedge against price movements in that currency by
entering into transactions using Hedging Instruments on another
17
<PAGE>
currency or a basket of currencies, the values of which Mitchell Hutchins
believes will have a high degree of positive correlation to the value of the
currency being hedged. The risk that movements in the price of the Hedging
Instrument will not correlate perfectly with movements in the price of the
currency being hedged is magnified when this strategy is used.
The value of Hedging Instruments on foreign currencies depends on the value
of the underlying currency relative to the U.S. dollar. Because foreign
currency transactions occurring in the interbank market might involve
substantially larger amounts than those involved in the use of such Hedging
Instruments, the Fund could be disadvantaged by having to deal in the odd lot
market (generally consisting of transactions of less than $1 million) for the
underlying foreign currencies at prices that are less favorable than for round
lots.
There is no systematic reporting of last sale information for foreign
currencies or any regulatory requirement that quotations available through
dealers or other market sources be firm or revised on a timely basis. Quotation
information generally is representative of very large transactions in the
interbank market and thus might not reflect odd-lot transactions where rates
might be less favorable. The interbank market in foreign currencies is a
global, round-the-clock market. To the extent the U.S. options or futures
markets are closed while the markets for the underlying currencies remain open,
significant price and rate movements might take place in the underlying markets
that cannot be reflected in the markets for the Hedging Instruments until they
reopen.
Settlement of hedging transactions involving foreign currencies might be
required to take place within the country issuing the underlying currency.
Thus, the Fund might be required to accept or make delivery of the underlying
foreign currency in accordance with any U.S. or foreign regulations regarding
the maintenance of foreign banking arrangements by U.S. residents and might be
required to pay any fees, taxes and charges associated with such delivery
assessed in the issuing country.
FORWARD CURRENCY CONTRACTS. The Fund may enter into forward currency
contracts to purchase or sell foreign currencies for a fixed amount of U.S.
dollars or another foreign currency. Such transactions may serve as long
hedges--for example, the Fund may purchase a forward currency contract to lock
in the U.S. dollar price of a security denominated in a foreign currency that
the Fund intends to acquire. Forward currency contract transactions may also
serve as short hedges--for example, the Fund may sell a forward currency
contract to lock in the U.S. dollar equivalent of the proceeds from the
anticipated sale of a security denominated in a foreign currency.
As noted above, the Fund may seek to hedge against changes in the value of a
particular currency by using forward contracts on another foreign currency or a
basket of currencies, the value of which Mitchell Hutchins believes will have a
positive correlation to the values of the currency being hedged. In addition,
the Fund may use forward currency contracts to shift exposure to foreign
currency fluctuations from one country to another. For example, if the Fund
owns securities denominated in a foreign currency and Mitchell Hutchins
believes that currency will decline relative to another currency, it might
enter into a forward contract to sell an appropriate amount of the first
foreign currency, with payment to be made in the second foreign currency.
Transactions that use two foreign currencies are sometimes referred to as
"cross hedging." Use of a different
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<PAGE>
foreign currency magnifies the risk that movements in the price of the Hedging
Instrument will not correlate or will correlate unfavorably with the foreign
currency being hedged.
The cost to the Fund of engaging in forward currency contracts varies with
factors such as the currency involved, the length of the contract period and
the market conditions then prevailing. Because forward currency contracts are
usually entered into on a principal basis, no fees or commissions are involved.
When the Fund enters into a forward currency contract, it relies on the contra
party to make or take delivery of the underlying currency at the maturity of
the contract. Failure by the contra party to do so would result in the loss of
any expected benefit of the transaction.
As is the case with futures contracts, holders and writers of forward
currency contracts can enter into offsetting closing transactions, similar to
closing transactions on futures, by selling or purchasing, respectively, an
instrument identical to the instrument purchased or sold. Secondary markets
generally do not exist for forward currency contracts, with the result that
closing transactions generally can be made for forward currency contracts only
by negotiating directly with the contra party. Thus, there can be no assurance
that the Fund will in fact be able to close out a forward currency contract at
a favorable price prior to maturity. In addition, in the event of insolvency of
the contra party, the Fund might be unable to close out a forward currency
contract at any time prior to maturity. In either event, the Fund would
continue to be subject to market risk with respect to the position, and would
continue to be required to maintain a position in the securities or currencies
that are the subject of the hedge or to maintain cash or securities in a
segregated account.
The precise matching of forward currency contract amounts and the value of
the securities involved generally will not be possible because the value of
such securities, measured in the foreign currency, will change after the
forward currency contract has been established. Thus, the Fund might need to
purchase or sell foreign currencies in the spot (cash) market to the extent
such foreign currencies are not covered by forward contracts. The projection of
short-term currency market movements is extremely difficult, and the successful
execution of a short-term hedging strategy is highly uncertain.
LIMITATIONS ON THE USE OF FORWARD CURRENCY CONTRACTS. The Fund may enter into
forward currency contracts or maintain a net exposure to such contracts only if
(1) the consummation of the contracts would not obligate the Fund to deliver an
amount of foreign currency in excess of the value of the position being hedged
by such contracts or (2) the Fund maintains in a segregated account cash, U.S.
government securities or other liquid high-grade debt securities in an amount
not less than the value of its total assets committed to the consummation of
the contract and not covered as provided in (1) above, marked to market daily.
INTEREST RATE PROTECTION TRANSACTIONS. The Fund may enter into interest rate
protection transactions, including interest rate swaps and interest rate caps,
collars and floors. Interest rate swap transactions involve an agreement
between two parties to exchange payments that are based, for example, on
variable and fixed rates of interest and that are calculated on the basis of a
specified amount of principal (the "notional principal amount") for a specified
period of time. Interest rate cap and floor transactions involve an agreement
between two parties in which the first party agrees
19
<PAGE>
to make payments to the counterparty when a designated market interest rate
goes above (in the case of a cap) or below (in the case of a floor) a
designated level on predetermined dates or during a specified time period.
Interest rate collar transactions involve an agreement between two parties in
which payments are made when a designated market interest rate either goes
above a designated ceiling level or goes below a designated floor level on
predetermined dates or during a specified time period. The Fund intends to use
these transactions as a hedge and not as a speculative investment. Interest
rate protection transactions are subject to risks comparable to those described
above with respect to other hedging strategies.
The Fund may enter into interest rate swaps, caps, collars and floors on
either an asset-based or liability-based basis, depending on whether it is
hedging its assets or its liabilities, and will usually enter into interest
rate swaps on a net basis, i.e., the two payment streams are netted out, with
the Fund receiving or paying, as the case may be, only the net amount of the
two payments. Inasmuch as these interest rate protection transactions are
entered into for good faith hedging purposes, and inasmuch as segregated
accounts will be established with respect to such transactions, Mitchell
Hutchins and the Fund believe such obligations do not constitute senior
securities and, accordingly, will not treat them as being subject to the Fund's
borrowing restrictions. The net amount of the excess, if any, of the Fund's
obligations over its entitlements with respect to each interest rate swap will
be accrued on a daily basis and appropriate Fund assets having an aggregate net
asset value at least equal to the accrued excess will be maintained in a
segregated account as described above in "Investment Policies and
Restrictions--Segregated Accounts." The Fund also will establish and maintain
such segregated accounts with respect to its total obligations under any
interest rate swaps that are not entered into on a net basis and with respect
to any interest rate caps, collars and floors that are written by the Fund.
The Fund will enter into interest rate protection transactions only with
banks and recognized securities dealers believed by Mitchell Hutchins to
present minimal credit risks in accordance with guidelines established by the
Trust's board of trustees. If there is a default by the other party to such a
transaction, the Fund will have to rely on its contractual remedies (which may
be limited by bankruptcy, insolvency or similar laws) pursuant to the
agreements related to the transaction.
The swap market has grown substantially in recent years with a large number
of banks and investment banking firms acting both as principals and as agents
utilizing standardized swap documentation. Caps, collars and floors are more
recent innovations for which documentation is less standardized, and
accordingly, they are less liquid than swaps.
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TRUSTEES AND OFFICERS
The trustees and executive officers of the Trust, their ages, business
addresses and principal occupations during the past five years are:
<TABLE>
<CAPTION>
POSITION WITH BUSINESS EXPERIENCE;
NAME, AGE AND ADDRESS* THE TRUST OTHER DIRECTORSHIPS
- ---------------------- ------------- --------------------
<S> <C> <C>
E. Garrett Bewkes, Jr.; Trustee and Mr. Bewkes is a director of Paine
68** Chairman of the Webber Group Inc. ("PW Group") (hold-
Board of Trustees ing company of PaineWebber and Mitch-
ell Hutchins) and a consultant to PW
Group. Prior to 1988, he was chairman
of the board, president and chief ex-
ecutive officer of American Bakeries
Company. Mr. Bewkes is also a direc-
tor of Interstate Bakeries Corpora-
tion and NaPro BioTherapeutics, Inc.
and a director or trustee of 26 other
investment companies for which Mitch-
ell Hutchins or PaineWebber serves as
investment adviser.
Meyer Feldberg; 52 Trustee Mr. Feldberg is Dean and Professor of
Columbia University Management of the Graduate School of
101 Uris Hall Business, Columbia University. Prior
New York, New York 10027 to 1989, he was president of the Il-
linois Institute of Technology. Dean
Feldberg is also a director of AMSCO
International Inc., Federated Depart-
ment Stores, Inc., Inco Homes Corpo-
ration and New World Communications
Group Incorporated and a director or
trustee of 18 other investment compa-
nies for which Mitchell Hutchins or
PaineWebber serves as investment ad-
viser.
George W. Gowen; 65 Trustee Mr. Gowen is a partner in the law firm
666 Third Avenue of Dunnington, Bartholow & Miller.
New York, New York 10017 Prior to May 1994, he was a partner
in the law firm of Fryer, Ross & Gow-
en. Mr. Gowen is also a director of
Columbia Real Estate Investments,
Inc. and a director or trustee of 16
other investment companies for which
Mitchell Hutchins or PaineWebber
serves as investment adviser.
</TABLE>
21
<PAGE>
<TABLE>
<CAPTION>
POSITION WITH BUSINESS EXPERIENCE;
NAME, AGE AND ADDRESS* THE TRUST OTHER DIRECTORSHIPS
- ---------------------- ------------- --------------------
<S> <C> <C>
Frederic V. Malek; 58 Trustee Mr. Malek is chairman of Thayer Capi-
901 15th Street, N.W. tal Partners (investment bank) and a
Suite 300 co-chairman and director of CB Com-
Washington, D.C. 20005 mercial Group Inc. (real estate).
From January 1992 to November 1992,
he was campaign manager of Bush-
Quayle '92. From 1990 to 1992, he was
vice chairman, and from 1989 to 1990,
he was president of Northwest Air-
lines Inc., NWA Inc. (holding company
of Northwest Airlines Inc.) and Wings
Holdings Inc. (holding company of NWA
Inc.). Prior to 1989, he was employed
by the Marriott Corporation (hotels,
restaurants, airline catering and
contract feeding), where he most re-
cently was an executive vice presi-
dent and president of Marriott Hotels
and Resorts. Mr. Malek is also a di-
rector of American Management Sys-
tems, Inc., Automatic Data Process-
ing, Inc., Avis, Inc., FPL Group,
Inc., ICF International, Manor Care,
Inc., National Education Corporation
and Northwest Airlines Inc. and a di-
rector or trustee of 16 other invest-
ment companies for which Mitchell
Hutchins or PaineWebber serves as in-
vestment adviser.
Frank P. L. Minard; 49** Trustee Mr. Minard is chairman of the board
and a director of Mitchell Hutchins,
chairman of the board of Mitchell
Hutchins Institutional Investors Inc.
and a director of PaineWebber. Prior
to 1993, Mr. Minard was managing di-
rector of Oppenheimer Capital in New
York and Director of Oppenheimer Cap-
ital Ltd. in London. Mr. Minard is
also president of 13, and a director
or trustee of 16, other investment
companies for which Mitchell Hutchins
or PaineWebber serves as investment
adviser.
</TABLE>
22
<PAGE>
<TABLE>
<CAPTION>
POSITION WITH BUSINESS EXPERIENCE;
NAME, AGE AND ADDRESS* THE TRUST OTHER DIRECTORSHIPS
- ---------------------- ------------- --------------------
<S> <C> <C>
Judith Davidson Moyers; Trustee Mrs. Moyers is president of Public Af-
59 fairs Television, Inc., an educa-
Public Affairs Televi- tional consultant and a home econo-
sion mist. Mrs. Moyers is also a director
356 W. 58th Street of Ogden Corporation and a director
New York, New York 10019 or trustee of 16 other investment
companies for which Mitchell Hutchins
or PaineWebber serves as investment
adviser.
Thomas F. Murray; 84 Trustee Mr. Murray is a real estate and finan-
400 Park Avenue cial consultant. Mr. Murray is also a
New York, New York 10022 director and chairman of American
Continental Properties, Inc., a
trustee of Prudential Realty Trust,
and a director or trustee of 16 other
investment companies for which Mitch-
ell Hutchins or PaineWebber serves as
investment adviser.
Teresa M. Boyle; 36 Vice President Ms. Boyle is a first vice president
and manager--advisory administration
of Mitchell Hutchins. Prior to Novem-
ber 1993, she was compliance manager
of Hyperion Capital Management, Inc.,
an investment advisory firm. Prior to
April 1993, Ms. Boyle was a vice
president and manager--legal adminis-
tration of Mitchell Hutchins. Ms.
Boyle is also a vice president of 39
other investment companies for which
Mitchell Hutchins or PaineWebber
serves as investment adviser.
Joan L. Cohen; 30 Vice President and Ms. Cohen is a vice president and at-
Assistant Secretary torney of Mitchell Hutchins. Prior to
December 1993, she was an associate
at the law firm of Seward & Kissel.
Ms. Cohen is also a vice president
and assistant secretary of 26 other
investment companies for which Mitch-
ell Hutchins or PaineWebber serves as
investment adviser.
</TABLE>
23
<PAGE>
<TABLE>
<CAPTION>
POSITION WITH BUSINESS EXPERIENCE;
NAME, AGE AND ADDRESS* THE TRUST OTHER DIRECTORSHIPS
- ---------------------- ------------- --------------------
<S> <C> <C>
Ellen R. Harris; 48 Vice President Ms. Harris is chief domestic equity
strategist and a managing director of
Mitchell Hutchins. Ms. Harris is also
a vice president of 19 other invest-
ment companies for which Mitchell
Hutchins or PaineWebber serves as in-
vestment adviser.
Mary B. King; 31 Vice President Mrs. King is a first vice president
and a portfolio manager of Mitchell
Hutchins. Mrs. King is also a vice
president of one other investment
company for which Mitchell Hutchins
or PaineWebber serves as investment
adviser.
Thomas J. Libassi; 36 Vice President Mr. Libassi is a senior vice president
of Mitchell Hutchins. Prior to May
1994, he was a vice president of Key-
stone Custodian Funds Inc. with port-
folio management responsibility. Mr.
Libassi is also a vice president of 2
other investment companies for which
Mitchell Hutchins or PaineWebber
serves as investment adviser.
Ann E. Moran; 37 Vice President Ms. Moran is a vice president of
and Assistant Mitchell Hutchins. Ms. Moran is also
Treasurer a vice president and assistant trea-
surer of 39 other investment compa-
nies for which Mitchell Hutchins or
PaineWebber serves as investment ad-
viser.
Dianne E. O'Donnell; 42 Vice President Ms. O'Donnell is a senior vice presi-
and Secretary dent and senior associate general
counsel of Mitchell Hutchins. Ms.
O'Donnell is also a vice president
and secretary of 39 other investment
companies for which Mitchell Hutchins
or PaineWebber serves as investment
adviser.
</TABLE>
24
<PAGE>
<TABLE>
<CAPTION>
POSITION WITH BUSINESS EXPERIENCE;
NAME, AGE AND ADDRESS* THE TRUST OTHER DIRECTORSHIPS
- ---------------------- ------------- --------------------
<S> <C> <C>
Victoria E. Schonfeld; Vice President Ms. Schonfeld is a managing director
44 and general counsel of Mitchell
Hutchins. From April 1990 to May
1994, she was a partner in the law
firm of Arnold & Porter. Prior to
April 1990, she was a partner in the
law firm of Shereff, Friedman, Hoff-
man & Goodman. Ms. Schonfeld is also
a vice president of 39 other invest-
ment companies for which Mitchell
Hutchins or PaineWebber serves as in-
vestment adviser.
Paul H. Schubert; 32 Vice President Mr. Schubert is a vice president of
and Assistant Mitchell Hutchins. From August 1992
Treasurer to August 1994, he was a vice presi-
dent at BlackRock Financial Manage-
ment L.P. Prior to August 1992, he
was an audit manager with Ernst &
Young LLP. Mr. Schubert is also a
vice president and assistant trea-
surer of 39 other investment compa-
nies for which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
Martha J. Slezak; 32 Vice President Ms. Slezak is a vice president of
and Assistant Mitchell Hutchins. From September
Treasurer 1991 to April 1992, she was
fundraising director for a U.S. Sen-
ate campaign. Prior to September
1991, she was a tax manager with Ar-
thur Andersen & Co. LLP. Ms. Slezak
is also a vice president and assis-
tant treasurer of 39 other investment
companies for which Mitchell Hutchins
or PaineWebber serves as investment
adviser.
Julian F. Sluyters; 34 Vice President Mr. Sluyters is a senior vice presi-
and Treasurer dent and the director of the mutual
fund finance division of Mitchell
Hutchins. Prior to 1991, he was an
audit senior manager with Ernst &
Young LLP. Mr. Sluyters is also a
vice president and treasurer of 39
other investment companies for which
Mitchell Hutchins or PaineWebber
serves as investment adviser.
</TABLE>
25
<PAGE>
<TABLE>
<CAPTION>
POSITION WITH BUSINESS EXPERIENCE;
NAME, AGE AND ADDRESS* THE TRUST OTHER DIRECTORSHIPS
- ---------------------- ------------- --------------------
<S> <C> <C>
Gregory K. Todd; 38 Vice President and Mr. Todd is a first vice president and
Assistant Secretary associate general counsel of Mitchell
Hutchins. Prior to 1993, he was a
partner in the law firm of Shereff,
Friedman, Hoffman & Goodman. Mr. Todd
is also a vice president and assis-
tant secretary of 39 other investment
companies for which Mitchell Hutchins
or PaineWebber serves as investment
adviser.
</TABLE>
- --------
* Unless otherwise indicated, the business address of each listed person is
1285 Avenue of the Americas, New York, New York 10019.
** Messrs. Bewkes and Minard are "interested persons" of the Trust as defined
in the Investment Company Act of 1940 ("1940 Act") by virtue of their
positions with PW Group, PaineWebber and/or Mitchell Hutchins.
The Trust pays trustees who are not "interested persons" of the Trust $5,000
annually and $250 per meeting of the board or any committee thereof. Trustees
are also reimbursed for any expenses incurred in attending meetings. Trustees
and officers of the Trust own in the aggregate less than 1% of the shares of
the Fund. Because Mitchell Hutchins and PaineWebber perform substantially all
of the services necessary for the operation of the Trust and the Fund, the
Trust requires no employees. No officer, director or employee of Mitchell
Hutchins or PaineWebber presently receives any compensation from the Trust for
acting as a trustee or officer. The table below includes certain information
relating to the compensation of the Trust's trustees for the fiscal year ended
November 30, 1994.
COMPENSATION TABLE
<TABLE>
<CAPTION>
PREFERRED
OR TOTAL
RETIREMENT COMPENSATION
BENEFITS FROM THE
ACCRUED AS TRUST AND
AGGREGATE PART OF ESTIMATED THE
COMPENSATION THE ANNUAL FUND COMPLEX
FROM TRUST'S BENEFITS UPON PAID TO
NAME OF PERSON, POSITION THE TRUST* EXPENSES RETIREMENT TRUSTEES+
------------------------ ------------ ---------- ------------- ------------
<S> <C> <C> <C> <C>
E. Garrett Bewkes, Jr.
Trustee and chairman of the
board of trustees......... -- -- -- --
Meyer Feldberg,
Trustee.................... $10,250 -- -- $86,050
George W. Gowen,
Trustee.................... $ 9,250 -- -- $71,425
Frederic V. Malek,
Trustee.................... $ 9,750 -- -- $77,875
</TABLE>
26
<PAGE>
<TABLE>
<CAPTION>
PREFERRED
OR TOTAL
RETIREMENT COMPENSATION
BENEFITS FROM THE
ACCRUED AS TRUST AND
AGGREGATE PART OF ESTIMATED THE
COMPENSATION THE ANNUAL FUND COMPLEX
FROM TRUST'S BENEFITS UPON PAID TO
NAME OF PERSON, POSITION THE TRUST* EXPENSES RETIREMENT TRUSTEES+
------------------------ ------------ ---------- ------------- ------------
<S> <C> <C> <C> <C>
Frank P.L. Minard,
Trustee................... -- -- -- --
Judith Davidson Moyers,
Trustee................... $9,750 -- -- $71,125
Thomas F. Murray,
Trustee................... $9,750 -- -- $71,925
</TABLE>
- --------
* Represents fees paid to each trustee during the fiscal year ended November
30, 1994.
+ Represents total compensation paid to each trustee during the calendar year
ended December 31, 1994.
INVESTMENT ADVISORY AND DISTRIBUTION ARRANGEMENTS
INVESTMENT ADVISORY ARRANGEMENTS. Mitchell Hutchins acts as the investment
adviser and administrator of the Fund pursuant to a contract with the Trust
dated April 21, 1988, as supplemented by a separate Fee Agreement dated May 1,
1992 ("Advisory Contract"). Under the Advisory Contract, the Trust pays
Mitchell Hutchins an annual fee of 0.70% of the Fund's average net assets,
computed daily and paid monthly.
For the fiscal year ended November 30, 1994 and the period July 2, 1993
(commencement of operations) to November 30, 1993, the Trust paid (or accrued)
to Mitchell Hutchins investment advisory and administration fees of $515,462
and $190,913, respectively.
Under a service agreement with the Trust, PaineWebber provides certain
services to the Fund not otherwise provided by its transfer agent. The
agreement is reviewed by the Trust's board of trustees annually. For the fiscal
year ended November 30, 1994 and the period July 2, 1993 (commencement of
operations) to November 30, 1993, PaineWebber earned fees under the service
agreement in the amounts of $28,223 and $10,021, respectively.
Under the terms of the Advisory Contract, the Fund bears all expenses
incurred in its operation that are not specifically assumed by Mitchell
Hutchins. General expenses of the Trust not readily identifiable as belonging
to the Fund or to the Trust's other series are allocated among series by or
under the direction of the board of trustees in such manner as the board deems
to be fair and equitable. Expenses borne by the Fund include the following (or
the Fund's share of the following): (1) the cost (including brokerage
commissions) of securities purchased or sold by the Fund and any losses
incurred in connection therewith; (2) fees payable to and expenses incurred on
behalf of the Fund by Mitchell Hutchins; (3) organizational expenses; (4)
filing fees and expenses relating to the registration and qualification of the
Fund's shares and the Trust under federal and state securities laws and
maintenance of such registrations and qualifications; (5) fees and salaries
payable to trustees who are not interested persons (as defined in the 1940 Act)
of the Trust or Mitchell Hutchins; (6) all expenses incurred in connection with
the trustees' services, including travel expenses; (7) taxes (including any
income or franchise taxes) and governmental fees; (8) costs of any liability,
uncollectible items of deposit and other insurance or fidelity bonds; (9) any
costs, expenses or losses
27
<PAGE>
arising out of a liability of or claim for damages or other relief asserted
against the Trust or the Fund for violation of any law; (10) legal, accounting
and auditing expenses, including legal fees of special counsel for the
independent trustees; (11) charges of custodians, transfer agents and other
agents; (12) costs of preparing share certificates; (13) expenses of setting in
type and printing prospectuses and supplements thereto, statements of
additional information and supplements thereto, reports and proxy materials for
existing shareholders, and costs of mailing such materials to shareholders;
(14) any extraordinary expenses (including fees and disbursements of counsel)
incurred by the Trust or the Fund; (15) fees, voluntary assessments and other
expenses incurred in connection with membership in investment company
organizations; (16) costs of mailing and tabulating proxies and costs of
meetings of shareholders, the board and any committees thereof; (17) the cost
of investment company literature and other publications provided to trustees
and officers; and (18) costs of mailing, stationery and communications
equipment.
As required by state regulation, Mitchell Hutchins will reimburse the Trust
or the Fund (as applicable) if and to the extent that the aggregate operating
expenses of the Fund exceed applicable limits in any fiscal year. Currently,
the most restrictive such limit applicable to the Fund is 2.5% of the first $30
million of the Fund's average daily net assets, 2.0% of the next $70 million of
its average daily net assets and 1.5% of its average daily net assets in excess
of $100 million. Certain expenses, such as brokerage commissions, taxes,
interest, distribution fees, certain expenses attributable to investing outside
the United States and extraordinary items, are excluded from this limitation.
No reimbursement pursuant to such limitation was required for the fiscal year
ended November 30, 1994 or the period ended November 30, 1993.
Under the Advisory Contract, Mitchell Hutchins will not be liable for any
error of judgment or mistake of law or for any loss suffered by the Fund in
connection with the performance of the Advisory Contract, except a loss
resulting from willful misfeasance, bad faith or gross negligence on the part
of Mitchell Hutchins in the performance of its duties or from reckless
disregard of its duties and obligations thereunder. The Advisory Contract
terminates automatically upon its assignment and is terminable at any time
without penalty by the Trust's board of trustees or by vote of the holders of a
majority of the Fund's outstanding voting securities, on 60 days' written
notice to Mitchell Hutchins or by Mitchell Hutchins on 60 days' written notice
to the Fund.
The following table shows the approximate net assets as of February 28, 1995,
sorted by category of investment objective, of the investment companies as to
which Mitchell Hutchins serves as adviser or sub-adviser. An investment company
may fall into more than one of the categories below.
<TABLE>
<CAPTION>
NET
ASSETS
INVESTMENT CATEGORY ($ MIL)
------------------- -------
<S> <C>
Domestic (excluding Money Market)............................... $ 5,772.8
Global.......................................................... 3,662.6
Equity/Balanced................................................. 2,804.0
Fixed Income (excluding Money Market)........................... 6,631.4
Taxable Fixed Income.......................................... 4,836.4
Tax-Free Fixed Income......................................... 1,795.0
Money Market Funds.............................................. 17,772.5
</TABLE>
Mitchell Hutchins personnel may invest in securities for their own accounts
pursuant to a code of ethics that describes the fiduciary duty owed to
shareholders of the PaineWebber and Mitchell
28
<PAGE>
Hutchins/Kidder, Peabody ("MH/KP") mutual funds and other Mitchell Hutchins'
advisory accounts by all Mitchell Hutchins' directors, officers and employees,
establishes procedures for personal investing and restricts certain
transactions. For example, employee accounts generally must be maintained at
PaineWebber, personal trades in most securities require pre-clearance and
short-term trading and participation in initial public offerings generally are
prohibited. In addition, the code of ethics puts restrictions on the timing of
personal investing in relation to trades by PaineWebber and MH/KP funds and
other Mitchell Hutchins advisory clients.
DISTRIBUTION ARRANGEMENTS. Mitchell Hutchins acts as the distributor of the
Class A, Class B and Class D shares of the Fund under separate distribution
contracts with the Trust dated July 7, 1993 (collectively, "Distribution
Contracts") that require Mitchell Hutchins to use its best efforts, consistent
with its other business, to sell shares of the Fund. Shares of the Fund are
offered continuously. Under separate exclusive dealer agreements between
Mitchell Hutchins and Paine Webber dated July 7, 1993 relating to the Class A,
Class B and Class D shares of the Fund (collectively, "Exclusive Dealer
Agreements"), PaineWebber and its correspondent firms sell the Fund's shares.
Under separate plans of distribution pertaining to the Class A, Class B and
Class D shares of the Fund adopted by the Trust in the manner prescribed under
Rule 12b-1 under the 1940 Act ("Class A Plan," "Class B Plan" and "Class D
Plan," collectively, "Plans"), the Fund pays Mitchell Hutchins a service fee,
accrued daily and payable monthly, at the annual rate of 0.25% of the average
daily net assets of each Class of shares. Under the Class B Plan and the Class
D Plan, the Fund also pays Mitchell Hutchins a distribution fee, accrued daily
and payable monthly, at the annual rate of 0.75% of the average daily net
assets of the Class B shares and Class D shares, respectively.
Among other things, each Plan provides that (1) Mitchell Hutchins will submit
to the Trust's board of trustees at least quarterly, and the trustees will
review, reports regarding all amounts expended under the Plan and the purposes
for which such expenditures were made, (2) the Plan will continue in effect
only so long as it is approved at least annually, and any material amendment
thereto is approved, by the Trust's board of trustees, including those trustees
who are not "interested persons" of the Trust and who have no direct or
indirect financial interest in the operation of the Plan or any agreement
related to the Plan, acting in person at a meeting called for that purpose, (3)
payments by the Fund under the Plan shall not be materially increased without
the affirmative vote of the holders of a majority of the outstanding shares of
the relevant Class and (4) while the Plan remains in effect, the selection and
nomination of trustees who are not "interested persons" of the Trust shall be
committed to the discretion of the trustees who are not "interested persons" of
the Trust.
In reporting amounts expended under the Plans to the trustees, Mitchell
Hutchins will allocate expenses attributable to the sale of each Class of Fund
shares to such Class based on the ratio of sales of such Class to the sales of
all three Classes of shares. The fees paid by one Class of Fund shares will not
be used to subsidize the sale of any other Class of Fund shares.
For the fiscal year ended November 30, 1994, the Fund paid (or accrued) the
following fees to Mitchell Hutchins under the Plans:
<TABLE>
<S> <C>
Class A............................................ $ 37,214
Class B............................................ $421,200
Class D............................................ $166,319
</TABLE>
29
<PAGE>
Mitchell Hutchins estimates that it and its parent corporation, PaineWebber,
incurred the following shareholder service-related and distribution-related
expenses with respect to the Fund during the fiscal year ended November 30,
1994:
<TABLE>
<CAPTION>
CLASS A
-------
<S> <C>
Marketing and advertising.............................................. $117,514
Printing of prospectuses and statements of additional information...... 780
Branch network costs allocated and interest expense.................... 72,526
Service fees paid to PaineWebber investment executives................. 16,747
<CAPTION>
CLASS B
-------
<S> <C>
Marketing and advertising.............................................. $246,925
Amortization of commissions............................................ 214,503
Printing of prospectuses and statements of additional information...... 1,447
Branch network costs allocated and interest expense.................... 183,076
Service fees paid to PaineWebber investment executives................. 47,385
<CAPTION>
CLASS D
-------
<S> <C>
Marketing and advertising.............................................. $143,129
Amortization of commissions............................................ 56,660
Printing of prospectuses and statements of additional information...... 1,049
Branch network costs allocated and interest expense.................... 98,876
Service fees paid to PaineWebber investment executives................. 18,711
</TABLE>
"Marketing and advertising" includes various internal costs allocated by
Mitchell Hutchins to its efforts in distributing Fund shares. These internal
costs encompass office rent, salaries and other overhead expenses of various
departments and areas of operations of Mitchell Hutchins. "Branch network costs
allocated and interest expense" consist of an allocated portion of the expenses
of various PaineWebber departments involved in the distribution of Fund shares,
including the PaineWebber retail branch system.
In approving the Fund's overall Flexible PricingSM system of distribution,
the Trust's board of trustees considered several factors, including that
implementation of Flexible Pricing would (1) enable investors to choose the
purchasing option better suited to their individual situation, thereby
encouraging current shareholders to make additional investments in the Fund and
attracting new investors and assets to the Fund to the benefit of the Fund and
its shareholders; (2) facilitate distribution of the Fund's shares; and (3)
maintain the competitive position of the Fund in relation to other funds that
have implemented or are seeking to implement similar distribution arrangements.
In approving the Class A Plan for the Fund, the trustees considered all the
features of the distribution system, including (1) the conditions under which
initial sales charges would be imposed and the amount of such charges, (2)
Mitchell Hutchins' belief that the initial sales charge combined with a service
fee would be attractive to PaineWebber investment executives and correspondent
firms, resulting in greater growth of the Fund than might otherwise be the
case, (3) the advantages to the shareholders of economies of scale resulting
from growth in the Fund's assets and potential
30
<PAGE>
continued growth, (4) the services provided to the Fund and its shareholders by
Mitchell Hutchins, (5) the services provided by PaineWebber pursuant to its
Exclusive Dealer Agreement with Mitchell Hutchins and (6) Mitchell Hutchins'
shareholder service-related expenses and costs.
In approving the Class B Plan for the Fund, the trustees considered all the
features of the distribution system, including (1) the conditions under which
contingent deferred sales charges would be imposed and the amount of such
charges, (2) the advantage to investors in having no initial sales charges
deducted from Fund purchase payments and instead having the entire amount of
their purchase payments immediately invested in Fund shares, (3) Mitchell
Hutchins' belief that the ability of PaineWebber investment executives and
correspondent firms to receive sales commissions when Class B shares are sold
and continuing service fees thereafter while their customers invest their
entire purchase payments immediately in Class B shares would prove attractive
to the investment executives and correspondent firms, resulting in greater
growth of the Fund than might otherwise be the case, (4) the advantages to the
shareholders of economies of scale resulting from growth in the Fund's assets
and potential continued growth, (5) the services provided to the Fund and its
shareholders by Mitchell Hutchins, (6) the services provided by PaineWebber
pursuant to its Exclusive Dealer Agreement with Mitchell Hutchins and (7)
Mitchell Hutchins' shareholder service- and distribution-related expenses and
costs. The trustees also recognized that Mitchell Hutchins' willingness to
compensate PaineWebber and its investment executives, without the concomitant
receipt by Mitchell Hutchins of initial sales charges, was conditioned upon its
expectation of being compensated under the Class B Plan.
In approving the Class D Plan for the Fund, the trustees considered all the
features of the distribution system, including (1) the advantage to investors
in having no initial sales charges deducted from the Fund's purchase payments
and instead having the entire amount of their purchase payments immediately
invested in Fund shares, (2) the advantage to investors in being free from
contingent deferred sales charges upon redemption and paying for distribution
on an ongoing basis, (3) Mitchell Hutchins' belief that the ability of
PaineWebber investment executives and correspondent firms to receive sales
compensation for their sales of Class D shares on an ongoing basis, along with
continuing service fees, while their customers invest their entire purchase
payments immediately in Class D shares and do not face contingent deferred
sales charges, would prove attractive to the investment executives and
correspondent firms, resulting in greater growth to the Fund than might
otherwise be the case, (4) the advantages to the shareholders of economies of
scale resulting from growth in the Fund's assets and potential continued
growth, (5) the services provided to the Fund and its shareholders by Mitchell
Hutchins, (6) the services provided by PaineWebber pursuant to its Exclusive
Dealer Agreement with Mitchell Hutchins and (7) Mitchell Hutchins' shareholder
service- and distribution-related expenses and costs. The trustees also
recognized that Mitchell Hutchins' willingness to compensate PaineWebber and
its investment executives without the concomitant receipt by Mitchell Hutchins
of initial sales charges or contingent deferred sales charges upon redemption
was conditioned upon its expectation of being compensated under the Class D
Plan.
With respect to each Plan, the trustees considered all compensation that
Mitchell Hutchins would receive under the Plan and the Distribution Contract,
including service fees and, as applicable, initial sales charges, distribution
fees and contingent deferred sales charges. The trustees
31
<PAGE>
also considered the benefits that would accrue to Mitchell Hutchins under each
Plan in that Mitchell Hutchins would receive service, distribution and advisory
fees that are calculated based upon a percentage of the average net assets of
the Fund, which fees would increase if the Plan were successful and the Fund
attained and maintained significant asset levels.
Under the Distribution Contract between the Trust and Mitchell Hutchins for
the Class A shares and a similar prior distribution contract, for the periods
set forth below, Mitchell Hutchins earned the following approximate amounts of
sales charges and retained the following approximate amounts, net of
concessions to PaineWebber as exclusive dealer.
<TABLE>
<CAPTION>
FOR THE PERIOD
FOR YEAR ENDED JULY 2, 1993*
NOVEMBER 30, 1994 TO NOVEMBER 30, 1993
----------------- --------------------
<S> <C> <C>
Earned............................. $74,565 $650,971
Retained........................... 4,440 72,315
</TABLE>
- --------
* Commencement of operations.
For the fiscal year ended November 30, 1994, Mitchell Hutchins earned and
retained approximately $302,602 in contingent deferred sales charges paid upon
certain redemptions of Class B shares.
PORTFOLIO TRANSACTIONS
Subject to policies established by the Trust's board of trustees, Mitchell
Hutchins is responsible for the execution of the Fund's portfolio transactions
and the allocation of brokerage transactions. In executing portfolio
transactions, Mitchell Hutchins seeks to obtain the best net results for the
Fund, taking into account such factors as the price (including the applicable
brokerage commission or dealer spread), size of order, difficulty of execution
and operational facilities of the firm involved. Prices paid to dealers in
principal transactions, through which most debt securities and some equity
securities are traded, generally include a "spread," which is the difference
between the prices at which the dealer is willing to purchase and sell a
specific security at the time. The Fund may invest in securities traded in the
OTC market, and will engage primarily in transactions with the dealers who make
markets in those securities, unless a better price or execution could be
obtained by using a broker. While Mitchell Hutchins generally seeks reasonably
competitive commission rates and dealer spreads, payment of the lowest
commission or spread is not necessarily consistent with obtaining the best net
results. For the fiscal year ended November 30, 1994 and the period
July 2, 1993 (commencement of operations) to November 30, 1993, the Fund paid
approximately $185,420 and $107,760, respectively, in brokerage commissions.
The Fund has no obligation to deal with any broker or group of brokers in the
execution of portfolio transactions. The Fund contemplates that, consistent
with the policy of obtaining the best net results, brokerage transactions may
be conducted through Mitchell Hutchins or its affiliates, including
PaineWebber. The Trust's board of trustees has adopted procedures in conformity
with Rule 17e-1 under the 1940 Act to ensure that all brokerage commissions
paid to Mitchell Hutchins and its affiliates are reasonable and fair. Specific
provisions in the Advisory Contract authorize Mitchell Hutchins and any of its
affiliates that is a member of a national securities exchange to effect
portfolio transactions for the Fund on such exchange and to retain compensation
in connection with such transactions. Any such transactions will be effected
and related compensation paid only in
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<PAGE>
accordance with applicable SEC regulations. For the fiscal year ended November
30, 1994 and the period July 2, 1993 (commencement of operations) to
November 30, 1993, the Fund paid no brokerage commissions to PaineWebber or any
other affiliate of Mitchell Hutchins.
Transactions in futures contracts are executed through futures commission
merchants ("FCMs"), who receive brokerage commissions for their services. The
Fund's procedures in selecting FCMs to execute the Fund's transactions in
futures contracts, including procedures permitting the use of Mitchell Hutchins
and its affiliates, are similar to those in effect with respect to brokerage
transactions in securities.
Consistent with the Fund's interests and subject to the review of the Trust's
board of trustees, Mitchell Hutchins may cause the Fund to purchase and sell
portfolio securities through brokers who provide the Fund with research,
analysis, advice and similar services. In return for such services, the Fund
may pay to those brokers a higher commission than may be charged by other
brokers, provided that Mitchell Hutchins determines in good faith that such
commission is reasonable in terms either of that particular transaction or of
the overall responsibility of Mitchell Hutchins to the Fund and its other
clients and that the total commissions paid by the Fund will be reasonable in
relation to the benefits to the Fund over the long term. For purchases or sales
with broker-dealer firms which act as principal, Mitchell Hutchins seeks best
execution. Although Mitchell Hutchins may receive certain research or execution
services in connection with these transactions, Mitchell Hutchins will not
purchase securities at a higher price or sell securities at a lower price than
would otherwise be paid if no weight was attributed to the services provided by
the executing dealer. Moreover, Mitchell Hutchins will not enter into any
explicit soft dollar arrangements relating to principal transactions and will
not receive in principal transactions the types of services which could be
purchased for hard dollars. Mitchell Hutchins may engage in agency transactions
in OTC equity and debt securities in return for research and execution
services. These transactions are entered into only in compliance with
procedures ensuring that the transaction (including commissions) is at least as
favorable as it would have been if effected directly with a market-maker that
did not provide research or execution services. These procedures include
Mitchell Hutchins receiving multiple quotes from dealers before executing the
transactions on an agency basis.
Research services furnished by brokers through which the Fund effects
securities transactions may be used by Mitchell Hutchins in advising other
funds or accounts and, conversely, research services furnished to Mitchell
Hutchins by brokers in connection with other funds or accounts Mitchell
Hutchins advises may be used by Mitchell Hutchins in advising the Fund.
Information and research received from such brokers will be in addition to, and
not in lieu of, the services required to be performed by Mitchell Hutchins
under the Advisory Contract. For the fiscal year ended November 30, 1994 and
the period July 2, 1993 (commencement of operations) to November 30, 1993,
Mitchell Hutchins directed no portfolio transactions to brokers chosen because
they provided research services. The Fund may purchase and sell portfolio
securities to and from dealers who provide the Fund with research services.
Portfolio transactions will not be directed by the Fund to dealers solely on
the basis of research services provided. Research services furnished by the
dealers through which or with which the Fund effects securities transactions
may be used by Mitchell Hutchins in advising other funds or accounts they
advise and, conversely, research services furnished to Mitchell Hutchins in
connection with other funds or accounts that Mitchell Hutchins advises may be
used in advising the Fund.
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<PAGE>
Investment decisions for the Fund and for other investment accounts managed
by Mitchell Hutchins are made independently of each other in light of differing
considerations for the various accounts. However, the same investment decision
may occasionally be made for the Fund and one or more of such accounts. In such
cases, simultaneous transactions are inevitable. Purchases or sales are then
averaged as to price and allocated between the Fund and such other account(s)
as to amount according to a formula deemed equitable to the Fund and such
account(s). While in some cases this practice could have a detrimental effect
upon the price or value of the security as far as the Fund is concerned or upon
its ability to complete its entire order, in other cases it is believed that
coordination and the ability to participate in volume transactions will be
beneficial to the Fund.
The Fund will not purchase securities that are offered in underwritings in
which Mitchell Hutchins or any of its affiliates is a member of the
underwriting or selling group, except pursuant to procedures adopted by the
Trust's board of trustees pursuant to Rule 10f-3 under the 1940 Act. Among
other things, these procedures require that the commission or spread paid in
connection with such a purchase be reasonable and fair, that the purchase be at
not more than the public offering price prior to the end of the first business
day after the date of the public offering and that Mitchell Hutchins or any
affiliate thereof not participate in or benefit from the sale to the Fund.
PORTFOLIO TURNOVER. The Fund's portfolio turnover rate may vary greatly from
year to year but it will not be a limiting factor when management deems
portfolio changes appropriate. The portfolio turnover rate is calculated by
dividing the lesser of the Fund's annual sales or purchases of portfolio
securities (exclusive of purchases or sales of securities whose maturities at
the time of acquisition were one year or less) by the monthly average value of
such securities in the portfolio during the year. For the fiscal year ended
November 30, 1994 and the period July 2, 1993 (commencement of operations) to
November 30, 1993, the Fund's portfolio turnover rate was 91.60% and 13.11%,
respectively.
REDUCED SALES CHARGES, ADDITIONAL EXCHANGE AND REDEMPTION
INFORMATION AND OTHER SERVICES
COMBINED PURCHASE PRIVILEGE--CLASS A SHARES. Investors and eligible groups of
related Fund investors may combine purchases of Class A shares of the Fund with
concurrent purchases of Class A shares of any other PaineWebber or MH/KP mutual
fund and thus take advantage of the reduced sales charges indicated in the
table of sales charges for Class A shares in the Prospectus. The sales charge
payable on the purchase of Class A shares of the Fund and Class A shares of
such other funds will be at the rates applicable to the total amount of the
combined concurrent purchases.
An "eligible group of related Fund investors" can consist of any combination
of the following:
(a) an individual, that individual's spouse, parents and children;
(b) an individual and his or her individual retirement account ("IRA");
(c) an individual (or eligible group of individuals) and any company
controlled by the individual(s) (a person, entity or group that holds 25%
or more of the outstanding voting securities of a corporation will be
deemed to control the corporation, and a partnership will be deemed to be
controlled by each of its general partners);
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<PAGE>
(d) an individual (or eligible group of individuals) and one or more
employee benefit plans of a company controlled by the individual(s);
(e) an individual (or eligible group of individuals) and a trust created
by the individual(s), the beneficiaries of which are the individual and/or
the individual's spouse, parents or children;
(f) an individual and a Uniform Gifts to Minors Act/Uniform Transfers to
Minors Act account created by the individual or the individual's spouse; or
(g) an employer (or group of related employers) and one or more qualified
retirement plans of such employer or employers (an employer controlling,
controlled by or under common control with another employer is deemed
related to that other employer).
RIGHTS OF ACCUMULATION--CLASS A SHARES. Reduced sales charges are available
through a right of accumulation, under which investors and eligible groups of
related Fund investors (as defined above) are permitted to purchase Class A
shares of the Fund among related accounts at the offering price applicable to
the total of (1) the dollar amount then being purchased plus (2) an amount
equal to the then-current net asset value of the purchaser's combined holdings
of Class A Fund shares and Class A shares of any other PaineWebber or MH/KP
mutual fund. The purchaser must provide sufficient information to permit
confirmation of his or her holdings, and the acceptance of the purchase order
is subject to such confirmation. The right of accumulation may be amended or
terminated at any time.
WAIVERS OF SALES CHARGES--CLASS B SHARES. Among other circumstances, the
contingent deferred sales charge on Class B shares is waived where a total or
partial redemption is made within one year following the death of the
shareholder. The contingent deferred sales charge waiver is available where the
decedent is either the sole shareholder or owns the shares with his or her
spouse as a joint tenant with right of survivorship. This waiver applies only
to redemption of shares held at the time of death.
Certain PaineWebber mutual funds offered shares subject to contingent
deferred sales charges before the implementation of the Flexible Pricing System
on July 1, 1991 ("CDSC Funds"). The contingent deferred sales charge is waived
with respect to redemptions of Class B shares of CDSC Funds purchased prior to
July 1, 1991 by officers, directors (trustees) or employees of the CDSC Funds,
Mitchell Hutchins or their affiliates (or their spouses and children under age
21). In addition, the contingent deferred sales charge will be reduced by 50%
with respect to redemptions of Class B shares of CDSC Funds purchased prior to
July 1, 1991 with a net asset value at the time of purchase of at least $1
million. If Class B shares of a CDSC Fund purchased prior to July 1, 1991 are
exchanged for Class B shares of the Fund, any waiver or reduction of the
contingent deferred sales charge that applied to the Class B Shares of the CDSC
Fund will apply to the Class B shares of the Fund acquired through the
exchange.
ADDITIONAL EXCHANGE AND REDEMPTION INFORMATION. As discussed in the
Prospectus, eligible shares of the Fund may be exchanged for shares of the
corresponding class of most other PaineWebber or MH/KP mutual funds.
Shareholders will receive at least 60 days' notice of any termination or
material modification of the exchange offer, except no notice need be given of
an amendment whose only material effect is to reduce the exchange fee, and no
notice need be given if, under extraordinary circumstances, either redemptions
are suspended under the circumstances described below or the Fund temporarily
delays or ceases the sales of its shares because it is unable to invest amounts
effectively in accordance with its investment objective, policies and
restrictions.
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<PAGE>
If conditions exist which make cash payments undesirable, the Fund reserves
the right to honor any request for redemption by making payment in whole or in
part in securities chosen by the Fund and valued in the same way as they would
be valued for purposes of computing the Fund's net asset value. If payment is
made in securities, a shareholder may incur brokerage expenses in converting
these securities into cash. The Trust has elected, however, to be governed by
Rule 18f-1 under the 1940 Act, under which the Fund is obligated to redeem
shares solely in cash up to the lesser of $250,000 or 1% of the net asset value
of the Fund during any 90-day period for one shareholder. This election is
irrevocable unless the SEC permits its withdrawal. The Fund may suspend
redemption privileges or postpone the date of payment during any period (1)
when the NYSE is closed or trading on the NYSE is restricted as determined by
the SEC, (2) when an emergency exists, as defined by the SEC, that makes it not
reasonably practicable for the Fund to dispose of securities owned by it or
fairly to determine the value of its assets or (3) as the SEC may otherwise
permit. The redemption price may be more or less than the shareholder's cost,
depending on the market value of the Fund's portfolio at the time.
SYSTEMATIC WITHDRAWAL PLAN. On or about the 15th of each month for monthly
plans and on or about the 15th of the months selected for quarterly or semi-
annual plans, PaineWebber will arrange for redemption by the Fund of sufficient
Fund shares to provide the withdrawal payment specified by participants in the
Fund's systematic withdrawal plan. The payment generally is mailed
approximately five business days after the redemption date. Withdrawal payments
should not be considered dividends, but redemption proceeds, with the tax
consequences described under 'Dividends and Taxes' in the Prospectus. If
periodic withdrawals continually exceed reinvested dividends, a shareholder's
investment may be correspondingly reduced. A shareholder may change the amount
of the systematic withdrawal or terminate participation in the plan at any time
without charge or penalty by written instructions with signatures guaranteed to
PaineWebber or PFPC Inc. ("Transfer Agent"). Instructions to participate in the
plan, change the withdrawal amount or terminate participation in the plan will
not be effective until five days after written instructions with signatures
guaranteed are received by the Transfer Agent. Shareholders may request the
forms needed to establish a systematic withdrawal plan from their PaineWebber
investment executives, correspondent firms or the Transfer Agent at 1-800-647-
1568.
REINSTATEMENT PRIVILEGE--CLASS A SHARES. As described in the Prospectus,
shareholders who have redeemed their Class A shares may reinstate their account
in the Fund without a sales charge. Shareholders may exercise the reinstatement
privilege by notifying the Transfer Agent of such desire and forwarding a check
for the amount to be purchased within 365 days after the date of redemption.
The reinstatement will be made at the net asset value per share next computed
after the notice of reinstatement and check are received. The amount of a
purchase under this reinstatement privilege cannot exceed the amount of the
redemption proceeds. Gain on a redemption is taxable regardless of whether the
reinstatement privilege is exercised; however, a loss arising out of a
redemption will not be deductible to the extent the redemption proceeds are
reinvested, if the reinstatement privilege is exercised within 30 days after
redemption, and an adjustment will be made to the shareholder's tax basis for
the shares acquired pursuant to the reinstatement privilege. Gain or loss on a
redemption also will be adjusted for federal income tax purposes by the amount
of any sales charge paid on Class A shares, under the circumstances and to the
extent described in "Dividends and Taxes" in the Prospectus.
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<PAGE>
PAINEWEBBER RMA RESOURCE ACCUMULATION PLAN SM; PAINEWEBBER RESOURCE MANAGEMENT
ACCOUNT(R) (RMA(R))
Shares of PaineWebber and MH/KP mutual funds (each a "PW Fund" and,
collectively, the "PW Funds") are available for purchase through the RMA
Resource Accumulation Plan ("Plan") by customers of PaineWebber and its
correspondent firms who maintain Resource Management Accounts ("RMA
accountholders"). The Plan allows an RMA accountholder to continually invest in
one or more of the PW Funds at regular intervals, with payment for shares
purchased automatically deducted from the client's RMA account. The client may
elect to invest at monthly or quarterly intervals and may elect either to
invest a fixed dollar amount (minimum $100 per period) or to purchase a fixed
number of shares. A client can elect to have Plan purchases executed on the
first or fifteenth day of the month. Settlement occurs five business days after
the trade date, and the purchase price of the shares is withdrawn from the
investor's RMA account on the settlement date from the following sources and in
the following order: uninvested cash balances, balances in RMA money market
funds, or margin borrowing power, if applicable to the account.
To participate in the Plan, an investor must be an RMA accountholder, must
have made an initial purchase of the shares of each PW Fund selected for
investment under the Plan (meeting applicable minimum investment requirements)
and must complete and submit the RMA Resource Accumulation Plan Client
Agreement and Instruction Form available from PaineWebber. The investor must
have received a current prospectus for each PW Fund selected prior to enrolling
in the Plan. Information about mutual fund positions and outstanding
instructions under the Plan are noted on the RMA accountholder's account
statement. Instructions under the Plan may be changed at any time, but may take
up to two weeks to become effective.
The terms of the Plan, or an RMA accountholder's participation in the Plan,
may be modified or terminated at any time. It is anticipated that, in the
future, shares of other PW Funds and/or mutual funds other than the PW Funds
may be offered through the Plan.
PERIODIC INVESTING AND DOLLAR COST AVERAGING. Periodic investing in the PW
Funds or other mutual funds, whether through the Plan or otherwise, helps
investors establish and maintain a disciplined approach to accumulating assets
over time, de-emphasizing the importance of timing the market's highs and lows.
Periodic investing also permits an investor to take advantage of "dollar cost
averaging." By investing a fixed amount in mutual fund shares at established
intervals, an investor purchases more shares when the price is lower and fewer
shares when the price is higher, thereby increasing his or her earning
potential. Of course, dollar cost averaging does not guarantee a profit or
protect against a loss in a declining market, and an investor should consider
his or her financial ability to continue investing through periods of low share
prices. However, over time, dollar cost averaging generally results in a lower
average original investment cost than if an investor invested a larger dollar
amount in a mutual fund at one time.
PAINEWEBBER'S RESOURCE MANAGEMENT ACCOUNT. In order to enroll in the Plan, an
investor must have opened an RMA account with PaineWebber or one of its
correspondent firms. The RMA account is PaineWebber's comprehensive asset
management account and offers investors a number of features, including the
following:
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<PAGE>
. monthly Premier account statements that itemize all account activity,
including investment transactions, checking activity and Gold
MasterCard (R) transactions during the period, and provide unrealized
and realized gain and loss estimates for most securities held in the
account;
. comprehensive preliminary 9-month and year-end summary statements that
provide information on account activity for use in tax planning and tax
return preparation;
. automatic "sweep" of uninvested cash into the RMA accountholder's
choice of one of the five RMA money market funds--RMA Money Market
Portfolio, RMA U.S. Government Portfolio, RMA Tax-Free Fund, RMA
California Municipal Money Fund and RMA New York Municipal Money Fund.
Each money market fund attempts to maintain a stable price per share of
$1.00, although there can be no assurance that it will be able to do
so. Investments in the money market funds are not insured or guaranteed
by the U.S. government;
. check writing, with no per-check usage charge, no minimum amount on
checks and no maximum number of checks that can be written. RMA
accountholders can code their checks to classify expenditures. All
canceled checks are returned each month;
. Gold MasterCard, with or without a line of credit, which provides RMA
accountholders with direct access to their accounts and can be used
with automatic teller machines worldwide. Purchases on the Gold
Mastercard are debited to the RMA account once monthly, permitting
accountholders to remain invested for a longer period of time;
. 24-hour access to account information through toll-free numbers, and
more detailed personal assistance during business hours form the RMA
Service Center;
. expanded account protection to $25 million in the event of the
liquidation of PaineWebber. This protection does not apply to shares of
the RMA money market funds or the PW Funds, because those shares are
held at the transfer agent and not through PaineWebber; and
. automatic direct deposit of checks into the investor's RMA account and
automatic withdrawals from the account.
The annual account fee for an RMA account is $85, which includes the Gold
MasterCard, with an additional fee of $40 if the investor selects an optional
line of credit with the Gold MasterCard.
CONVERSION OF CLASS B SHARES
Class B shares of the Fund will automatically convert to Class A shares,
based on the relative net asset value per share of each of the two Classes, as
of the close of business on the first Business Day (as defined below) of the
month in which the sixth anniversary of the initial issuance of such Class B
shares of the Fund occurs. For the purpose of calculating the holding period
required for conversion of Class B shares, the date of initial issuance shall
mean (1) the date on which such Class B shares were issued, or (2) for Class B
shares obtained through an exchange, or a series of exchanges, the date on
which the original Class B shares were issued. For purposes of conversion to
Class A, Class B shares purchased through the reinvestment of dividends and
other distributions
38
<PAGE>
paid in respect of Class B shares will be held in a separate sub-account. Each
time any Class B shares in the shareholder's regular account (other than those
in the sub-account) convert to Class A, a pro rata portion of the Class B
shares in the sub-account will also convert to Class A. The portion will be
determined by the ratio that the shareholder's Class B shares converting to
Class A bears to the shareholder's total Class B shares not acquired through
dividends and other distributions.
The availability of the conversion feature is subject to (1) the continuing
applicability of a ruling of the Internal Revenue Service that the dividends
and other distributions paid on Class A and Class B shares will not result in
"preferential dividends" under the Internal Revenue Code and (2) the
continuing availability of an opinion of counsel to the effect that the
conversion of shares does not constitute a taxable event. If the conversion
feature ceased to be available, the Class B shares of the Fund would not be
converted and would continue to be subject to the higher ongoing expenses of
the Class B shares beyond six years from the date of purchase. Mitchell
Hutchins has no reason to believe that these conditions for the availability
of the conversion feature will not continue to be met.
VALUATION OF SHARES
The Fund determines its net asset value per share separately for each Class
of shares as of the close of regular trading (currently 4:00 p.m., eastern
time) on the NYSE on each Business Day, which is defined as each Monday
through Friday when the NYSE is open. Currently, the NYSE is closed on the
observance of the following holidays: New Year's Day, Presidents' Day, Good
Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and
Christmas Day.
Securities that are listed on U.S. and foreign stock exchanges are valued at
the last sale price on the day the securities are being valued or, lacking any
sales on such day, at the last available bid price. In cases where securities
are traded on more than one exchange, the securities are generally valued on
the exchange considered by Mitchell Hutchins as the primary market. Securities
traded in the OTC market and listed on Nasdaq are valued at the last available
sale price on Nasdaq at 4:00 p.m., eastern time; other OTC securities are
valued at the last bid price available prior to valuation. Securities and
assets for which market quotations are not readily available are valued at
fair value as determined in good faith by or under the direction of the
Trust's board of trustees. All investments quoted in foreign currency are
valued daily in U.S. dollars on the basis of the foreign currency exchange
rate prevailing at the time such valuation is determined by the Fund's
custodian. The amortized cost method of valuation generally is used to value
debt obligations with 60 days or less remaining until maturity, unless the
board of trustees determines that this does not represent fair value.
Foreign currency exchange rates are generally determined prior to the close
of trading on the NYSE. Occasionally events affecting the value of foreign
investments and such exchange rates occur between the time at which they are
determined and the close of trading on the NYSE, which events will not be
reflected in a computation of the Fund's net asset value on that day. If
events materially affecting the value of such investments or currency exchange
rates occur during such time period, the investments will be valued at their
fair value as determined in good faith by or under the direction of the
Trust's board of trustees. The foreign currency exchange transactions of the
Fund conducted on a spot (that is, cash) basis are valued at the spot rate for
purchasing or selling currency
39
<PAGE>
prevailing on the foreign exchange market. This rate under normal market
conditions differs from the prevailing exchange rate in an amount generally
less than one-tenth of one percent due to the costs of converting from one
currency to another.
PERFORMANCE INFORMATION
The Fund's performance data quoted in advertising and other promotional
materials ("Performance Advertisements") represent past performance and are
not intended to indicate future performance. The investment return and
principal value of an investment will fluctuate so that an investor's shares,
when redeemed, may be worth more or less than their original cost.
TOTAL RETURN CALCULATIONS. Average annual total return quotes ("Standardized
Return") used in the Fund's Performance Advertisements are calculated
according to the following formula:
P(1 + T)/n/ = ERV
Where: P = a hypothetical initial payment of $1,000 to purchase shares of a
specified Class
T = average annual total return of that Class
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment made at
the beginning of that period.
Under the foregoing formula, the time periods used in Performance
Advertisements will be based on rolling calendar quarters, updated to the last
day of the most recent quarter prior to submission of the advertisement for
publication. Total return, or 'T' in the formula above, is computed by finding
the average annual change in the value of an initial $1,000 investment over
the period. In calculating the ending redeemable value for Class A shares, the
maximum 4.5% initial sales charge is deducted from the initial $1,000 payment
and, for Class B shares, the applicable contingent deferred sales charge
imposed on a redemption of Class B shares held for the period is deducted. All
dividends and other distributions are assumed to have been reinvested at net
asset value.
The Fund also may refer in Performance Advertisements to total return
performance data that are not calculated according to the formula set forth
above ('Non-Standardized Return'). The Fund calculates Non-Standardized Return
for specified periods of time by assuming an investment of $1,000 in Fund
shares and assuming the reinvestment of all dividends and other distributions.
The rate of return is determined by subtracting the initial value of the
investment from the ending value and by dividing the remainder by the initial
value. Neither initial nor contingent deferred sales charges are taken into
account in calculating Non-Standardized Return; the inclusion of these charges
would reduce the return.
Both Standardized Return and Non-Standardized Return for Class B shares for
periods of over six years will reflect conversion of the Class B shares to
Class A shares at the end of the sixth year.
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The following table shows performance information for the Class A, Class B
and Class D shares of the Fund for the periods indicated. All returns for
periods of more than one year are expressed as an average return.
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS D
-------- -------- -------
<S> <C> <C> <C>
Fiscal year ended November 30, 1994:
Standardized Return*............................... (12.90)% (14.35)% (9.36)%
Non-Standardized Return............................ (8.76)% (9.35)% (9.36)%
Inception** to November 30, 1994:
Standardized Return*............................... (10.53)% (11.17)% (8.22)%
Non-Standardized Return............................ (7.57)% (8.22)% (8.22)%
</TABLE>
- --------
* All Standardized Return figures for Class A shares reflect deduction of the
current maximum initial sales charge of 4.5%. All Standardized Return
figures for Class B shares reflect deduction of the applicable contingent
deferred sales charge imposed on a redemption of shares held for the period.
Class D shares do not impose an initial or contingent deferred sales charge;
therefore, Non-Standardized Return is identical to Standardized Return.
** The inception date for each Class of shares is July 2, 1993.
YIELD. Yields used in the Fund's Performance Advertisements are calculated by
dividing the Fund's dividend and interest income attributable to a Class of
shares for a 30-day period ("Period"), net of expenses attributable to such
Class, by the average number of shares of such Class entitled to receive
dividends during the Period and expressing the result as an annualized
percentage (assuming semi-annual compounding) of the maximum offering price per
share (in the case of Class A shares) or the net asset value per share (in the
case of Class B and Class D shares) at the end of the Period. Yield quotations
are calculated according to the following formula:
a-b
PRICE YIELD = 2[(--- + 1)/6/-1]
cd
where a = dividends and interest earned during the Period attributable
to a Class of shares
b = expenses accrued for the Period attributable to a Class of
shares (net of reimbursements)
c = the average daily number of shares of a Class outstanding
during the Period that were entitled to receive dividends
d = the maximum offering price per share (in the case of Class A
shares) or the net asset value per share (in the case of
Class B and Class D shares) on the last day of the Period.
Solely for the purpose of computing yield, the Fund may recognize dividend
income by accruing 1/360 of the stated dividend rate of the security each day
that the security is in the portfolio.
Except as noted below, in determining interest income earned during the
Period (variable "a" in the above formula), the Fund calculates interest earned
on each debt obligation held by it during
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<PAGE>
the Period by (1) computing the obligation's yield to maturity, based on the
market value of the obligation (including actual accrued interest) on the last
business day of the Period or, if the obligation was purchased during the
Period, the purchase price plus accrued interest and (2) dividing the yield to
maturity by 360, and multiplying the resulting quotient by the market value of
the obligation (including actual accrued interest) to determine the interest
income on the obligation for each day of the period that the obligation is in
the portfolio. Once interest earned is calculated in this fashion for each debt
obligation held by the Fund, interest earned during the Period is then
determined by totalling the interest earned on all debt obligations.
For purposes of these calculations, the maturity of an obligation with one or
more call provisions is assumed to be the next date on which the obligation
reasonably can be expected to be called or, if none, the maturity date. With
respect to Class A shares, in calculating the maximum offering price per share
at the end of the Period (variable "d" in the above formula), the Fund's
current maximum 4.5% initial sales charge on Class A shares is included. For
the 30-day period ended November 30, 1994, the yields for the Class A, Class B
and Class D shares were 5.52%, 5.02% and 5.01%, respectively.
OTHER INFORMATION. In Performance Advertisements, the Fund may compare its
Standardized Return and/or its Non-Standardized Return with data published by
Lipper Analytical Services, Inc. for utility funds ("Lipper"), CDA Investment
Technologies, Inc. ("CDA"), Wiesenberger Investment Company Service
("Wiesenberger"), Investment Company Data Inc. ("ICD"), Ibbotson Associates,
Inc. ("Ibbotson"), the Investment Company Institute ("ICI"), Value Line
Investment Survey ("Value Line") or Morningstar Mutual Funds ("Morningstar"),
or with the performance of recognized stock and other indices, including the
Standard & Poor's 500 Composite Stock Price Index, the Standard & Poor's 40
Utilities Index, the Standard & Poor's Electric Utilities Index, the Dow Jones
Utilities Average, Moody's Electric Utilities Averages, Lehman Brother's
Corporate Bond Utility Index, Lehman Brothers Government/Corporate Bond Index
and U.S. Treasury bonds, bills and notes, as well as changes in the Consumer
Price Index as published by the U.S. Department of Commerce. The Fund also may
refer in such materials to mutual fund performance rankings and other data,
such as comparative asset, expense and fee levels, published by Lipper, CDA,
Wiesenberger, ICD or Morningstar. The Fund may also include comparisons of the
performance of utilities securities in general as measured by various
recognized indices as compared to other recognized stock and other indices
including those described above and general trends of dividend growth, total
return, yield and other standard measures of performance of utilities
securities in general. Performance Advertisements also may refer to discussions
of the Fund and comparative mutual fund data and ratings reported in
independent periodicals, including (but not limited to) THE WALL STREET
JOURNAL, MONEY Magazine, FORBES, BUSINESS WEEK, FINANCIAL WORLD, BARRON'S,
FORTUNE, THE NEW YORK TIMES, THE CHICAGO TRIBUNE, THE WASHINGTON POST and THE
KIPLINGER LETTERS. Comparisons in Performance Advertisements may be in graphic
form.
The Fund may include discussions or illustrations of the effects of
compounding in Performance Advertisements. "Compounding" refers to the fact
that, if dividends or other distributions on a Fund investment are reinvested
in additional Fund shares, any future income or capital appreciation of the
Fund would increase the value, not only of the original Fund investment, but
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also of the additional Fund shares received through reinvestment. As a result,
the value of the Fund investment would increase more quickly than if dividends
or other distributions had been paid in cash.
The Fund may also compare its performance with the performance of bank
certificates of deposit ("CDs") as measured by the CDA Investment Technologies,
Inc. Certificate of Deposit Index and the Bank Rate Monitor National Index and
the averages of yields of CDs of major banks published by Banxquote (R) Money
Markets. In comparing the Fund's performance to CD performance, investors
should keep in mind that bank CDs are insured in whole or part by an agency of
the U.S. government and offer fixed principal and fixed or variable rates of
interest, and that bank CD yields may vary depending on the financial
institution offering the CD and prevailing interest rates. Fund shares are not
insured or guaranteed by the U.S. government and returns thereon and net asset
value will fluctuate. The securities held by the Fund generally have longer
maturities than most CDs and may reflect interest rate fluctuations for longer
term securities. An investment in the Fund involves greater risks than an
investment in either a money market fund or a CD.
TAXES
In order to continue to qualify for treatment as a regulated investment
company ("RIC") under the Internal Revenue Code, the Fund must distribute to
its shareholders for each taxable year at least 90% of its investment company
taxable income (consisting generally of net investment income, net gains from
certain foreign currency transactions and net short-term capital gain)
("Distribution Requirement") and must meet several additional requirements.
These requirements include the following: (1) the Fund must derive at least 90%
of its gross income each taxable year from dividends, interest, payments with
respect to securities loans and gains from the sale or other disposition of
securities or foreign currencies, or other income (including gains from
options, futures or forward currency contracts) derived with respect to its
business of investing in securities or those currencies ("Income Requirement");
(2) the Fund must derive less than 30% of its gross income each taxable year
from the sale or other disposition of securities, or any of the following, that
were held for less than three months--options, futures or forward contracts
(other than those on foreign currencies), or foreign currencies (or options,
futures or forward contracts thereon) that are not directly related to the
Fund's principal business of investing in securities (or options and futures
with respect to securities) ("Short-Short Limitation"); (3) at the close of
each quarter of the Fund's taxable year, at least 50% of the value of its total
assets must be represented by cash and cash items, U.S. government securities,
securities of other RICs and other securities, with these other securities
limited, in respect of any one issuer, to an amount that does not exceed 5% of
the value of the Fund's total assets and that does not represent more than 10%
of the issuer's outstanding voting securities; and (4) at the close of each
quarter of the Fund's taxable year, not more than 25% of the value of its total
assets may be invested in securities (other than U.S. government securities or
the securities of other RICs) of any one issuer.
Dividends and other distributions declared by the Fund in October, November
or December of any year and payable to its shareholders of record on a date in
any of those months will be deemed to have been paid by the Fund and received
by the shareholders on December 31 of that
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year if the distributions are paid by the Fund during the following January.
Accordingly, those distributions will be taxed to shareholders for the year in
which that December 31 falls.
A portion of the dividends from the Fund's investment company taxable income
(whether paid in cash or reinvested in additional Fund shares) may be eligible
for the dividends-received deduction allowed to corporations. The eligible
portion may not exceed the aggregate dividends received by the Fund from U.S.
corporations. However, dividends received by a corporate shareholder and
deducted by it pursuant to the dividends-received deduction are subject
indirectly to the alternative minimum tax.
If Fund shares are sold at a loss after being held for six months or less,
the loss will be treated as long-term, instead of short-term, capital loss to
the extent of any capital gain distributions received on those shares.
Investors also should be aware that if shares are purchased shortly before the
record date for any dividend or capital gain distribution, the investor will
pay full price for the shares and receive some portion of the price back as a
taxable distribution.
Dividends and interest received by the Fund may be subject to income,
withholding or other taxes imposed by foreign countries and U.S. possessions
that would reduce the yield on its securities. Tax conventions between certain
countries and the United States may reduce or eliminate these foreign taxes,
however, and many foreign countries do not impose taxes on capital gains in
respect of investments by foreign investors. If more than 50% of the value of
the Fund's total assets at the close of its taxable year consists of securities
of foreign corporations, the Fund will be eligible to, and may, file an
election with the Internal Revenue Service that will enable Fund shareholders,
in effect, to receive the benefit of the foreign tax credit with respect to any
foreign and U.S. possessions income taxes paid by the Fund. Pursuant to the
election, the Fund will treat those taxes as dividends paid to its shareholders
and each shareholder will be required to (1) include in gross income, and treat
as paid by him, his proportionate share of those taxes, (2) treat his share of
those taxes and of any dividend paid by the Fund that represents income from
foreign or U.S. possessions sources as his own income from those sources and
(3) either deduct the taxes deemed paid by him in computing his taxable income
or, alternatively, use the foregoing information in calculating the foreign tax
credit against his federal income tax. The Fund will report to its shareholders
shortly after each taxable year their respective shares of the Fund's income
from sources within, and taxes paid to, foreign countries and U.S. possessions
if it makes this election.
The Fund will be subject to a nondeductible 4% excise tax ("Excise Tax") to
the extent it fails to distribute by the end of any calendar year substantially
all of its ordinary income for that year and capital gain net income for the
one-year period ending on November 30 of that year, plus certain other amounts.
The Fund may invest in the stock of "passive foreign investment companies"
("PFICs") if such stock is denominated in U.S. dollars and otherwise is a
permissible investment. A PFIC is a foreign corporation that, in general, meets
either of the following tests: (1) at least 75% of its gross income is passive
or (2) an average of at least 50% of its assets produce, or are held for the
production of, passive income. Under certain circumstances, the Fund will be
subject to federal income tax on a portion of any "excess distribution"
received on the stock of a PFIC or of any gain from disposition of such stock
(collectively "PFIC income"), plus interest thereon, even if the Fund
distributes the
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PFIC income as a taxable dividend to its shareholders. The balance of the PFIC
income will be included in the Fund's investment company taxable income and,
accordingly, will not be taxable to it to the extent that income is distributed
to its shareholders. If the Fund invests in a PFIC and elects to treat the PFIC
as a "qualified electing fund," then in lieu of the foregoing tax and interest
obligation, the Fund will be required to include in income each year its pro
rata share of the qualified electing fund's annual ordinary earnings and net
capital gain (the excess of net long-term capital gain over net short-term
capital loss)--which may have to be distributed to satisfy the Distribution
Requirement and avoid imposition of the Excise Tax--even if those earnings and
gain are not distributed to the Fund. In most instances it will be very
difficult, if not impossible, to make this election because of certain
requirements thereof.
The "Tax Simplification and Technical Corrections Bill of 1993," passed in
May 1994 by the House of Representatives, would substantially modify the
taxation of U.S. shareholders of foreign corporations, including eliminating
the provisions described above dealing with PFICs and replacing them (and other
provisions) with a regulatory scheme involving entities called "passive foreign
corporations." Three similar bills were passed by Congress in 1991 and 1992 and
vetoed. It is unclear at this time whether, and in what form, the proposed
modifications may be enacted into law.
Pursuant to proposed regulations, open-end RICs, such as the Fund, would be
entitled to elect to "mark-to-market" their stock in certain PFICs. "Marking-
to-market," in this context, means recognizing as gain for each taxable year
the excess, as of the end of that year, of the fair market value of such a
PFIC's stock over the owner's adjusted basis in that stock (including mark-to-
market gain for each prior year for which an election was in effect).
The use of hedging and option income strategies, such as writing (selling)
and purchasing options and futures contracts and entering into forward currency
contracts, involves complex rules that will determine for income tax purposes
the character and timing of recognition of the gains and losses the Fund
recognizes in connection therewith. Income from foreign currencies (except
certain gains therefrom that may be excluded by future regulations), and income
from transactions in options, futures and forward currency contracts derived by
the Fund with respect to its business of investing in securities or foreign
currencies, will qualify as permissible income under the Income Requirement.
However, income from the disposition of options and futures contracts (other
than those on foreign currencies) will be subject to the Short-Short Limitation
if they are held for less than three months. Income from the disposition of
foreign currencies, and options, futures and forward contracts on foreign
currencies, that are not directly related to the Fund's principal business of
investing in securities (or options and futures with respect to securities)
also will be subject to the Short-Short Limitation if they are held for less
than three months.
If the Fund satisfies certain requirements, any increase in value of a
position that is part of a "designated hedge" will be offset by any decrease in
value (whether realized or not) of the offsetting hedging position during the
period of the hedge for purposes of determining whether the Fund satisfies the
Short-Short Limitation. Thus, only the net gain (if any) from the designated
hedge will be included in gross income for purposes of that limitation. The
Fund will consider whether it should seek to qualify for this treatment for its
hedging transactions. To the extent the Fund does not qualify for this
treatment, it may be forced to defer the closing out of certain options,
futures
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and forward currency contracts beyond the time when it otherwise would be
advantageous to do so, in order for the Fund to continue to qualify as a RIC.
OTHER INFORMATION
PAINEWEBBER MANAGED INVESTMENTS TRUST. Prior to February 26, 1992, the
Trust's name was "PaineWebber Fixed Income Portfolios." The Trust is an entity
of the type commonly known as a "Massachusetts business trust." Under
Massachusetts law, shareholders of the Fund could, under certain circumstances,
be held personally liable for the obligations of the Fund. However, the Trust's
Declaration of Trust disclaims shareholder liability for acts or obligations of
the Trust or the Fund and requires that notice of such disclaimer be given in
each note, bond, contract, instrument, certificate or undertaking made or
issued by the trustees or by any officers or officer by or on behalf of the
Trust, the Fund, the trustees or any of them in connection with the Trust. The
Declaration of Trust provides for indemnification from the Fund's property for
all losses and expenses of any Fund shareholder held personally liable for the
obligations of the Fund. Thus, the risk of a shareholder's incurring financial
loss on account of a shareholder liability is limited to circumstances in which
the Fund itself would be unable to meet its obligations, a possibility which
Mitchell Hutchins believes is remote and not material. Upon payment of any
liability incurred by a shareholder solely by reason of being or having been a
shareholder, the shareholder paying such liability will be entitled to
reimbursement from the general assets of the Fund. The trustees intend to
conduct the Fund's operations in such a way as to avoid, as far as possible,
ultimate liability of the shareholders for liabilities of the Fund.
CLASS-SPECIFIC EXPENSES. The Fund may determine to allocate certain of its
expenses (in addition to distribution fees) to the specific Classes of the
Fund's shares to which those expenses are attributable. For example, Class B
shares bear higher transfer agency fees per shareholder account than those
borne by Class A shares. The higher fee is imposed due to the higher costs
incurred by the Transfer Agent in tracking shares subject to a contingent
deferred sales charge because, upon redemption, the duration of the
shareholder's investment must be determined in order to determine the
applicable charge. Moreover, the tracking and calculations required by the
automatic conversion feature of the Class B shares will cause the Transfer
Agent to incur additional costs. Although the transfer agency fee will differ
on a per account basis as stated above, the specific extent to which the
transfer agency fees will differ between the Classes as a percentage of net
assets is not certain, because the fee as a percentage of net assets will be
affected by the number of shareholder accounts in each Class and the relative
amounts of net assets in each Class.
COUNSEL. The law firm of Kirkpatrick & Lockhart LLP, 1800 M Street, N.W.,
Washington, D.C. 20036-5891, counsel to the Fund, has passed upon the legality
of the shares offered by the Fund's Prospectus. Kirkpatrick & Lockhart LLP also
acts as counsel to Mitchell Hutchins and PaineWebber in connection with other
matters.
INDEPENDENT AUDITORS. Ernst & Young LLP, 787 Seventh Avenue, New York, New
York 10019, serves as the Trust's independent auditors.
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FINANCIAL STATEMENTS
The Fund's Annual Report to Shareholders for the fiscal year ended November
30, 1994 is a separate document supplied with this Statement of Additional
Information and the financial statements, accompanying notes and report of
independent auditors appearing therein are incorporated by reference in this
Statement of Additional Information.
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APPENDIX
DESCRIPTION OF MOODY'S INVESTORS SERVICES, INC. ("MOODY'S") CORPORATE BOND
RATINGS
AAA. Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt edged." Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements
are likely to change, such changes as can be visualized are most unlikely to
impair the fundamentally strong position of such issues; AA. Bonds 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 obligations, i.e., they are neither highly
protected nor poorly secured. Interest payments and principal security appear
adequate for the present but certain protective elements may be lacking or may
be characteristically unreliable over any great length of time. Such bonds lack
outstanding investment characteristics and in fact have speculative
characteristics as well; BA. 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
thereby 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 the 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 represent obligations which are speculative in a high degree. Such
issues are often in default or have other marked shortcomings; C. Bonds which
are rated C are 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.
Note: Moody's may apply numerical modifiers, 1, 2 and 3 in each generic
rating classification from Aa through B in its corporate bond rating system.
The modifier 1 indicates that the security ranks in the higher end of its
generic rating category; the modifier 2 indicates a mid-range ranking; and the
modifier 3 indicates that the issue ranks in the lower end of its generic
rating category.
DESCRIPTION OF STANDARD & POOR'S RATINGS GROUP ("S&P") CORPORATE DEBT RATINGS
AAA. Debt rated AAA has the highest rating assigned by S&P. 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 it is somewhat more
susceptible to the adverse effects of changes in circumstances and economic
conditions than debt in higher
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rated categories; BBB. Debt rated BBB is regarded as having 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;
BB, B, CCC, CC, C. Debt rated BB, B, CCC, CC and C is regarded, on balance, as
predominantly speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligation. BB indicates the
lowest degree of speculation and C the highest degree of speculation. While
such debt will likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major risk exposures to adverse
conditions; CI. The rating CI is reserved for income bonds on which no interest
is being paid; D. Debt rated D is in default, and payment of interest and/or
repayment of principal is in arrears.
Plus (+) or Minus (--): The ratings from "AA" to "CCC" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
NR indicates that no public rating has been requested, that there is
insufficient information on which to base a rating or that S&P does not rate a
particular type of obligation as a matter of policy.
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NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS NOT CONTAINED IN THE PROSPECTUS OR IN THIS STATEMENT OF
ADDITIONAL INFORMATION IN CONNECTION WITH THE OFFERING MADE BY THE PROSPECTUS
AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED
UPON AS HAVING BEEN AUTHORIZED BY THE FUND OR ITS DISTRIBUTOR. THE PROSPECTUS
AND THIS STATEMENT OF ADDITIONAL INFORMATION DO NOT CONSTITUTE AN OFFERING BY
THE FUND OR BY ITS DISTRIBUTOR IN ANY JURISDICTION IN WHICH SUCH OFFERING MAY
NOT LAWFULLY BE MADE.
-----------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Policies and Restrictions...................................... 1
Hedging and Related Income Strategies..................................... 11
Trustees and Officers..................................................... 21
Investment Advisory and Distribution Arrangements......................... 27
Portfolio Transactions.................................................... 32
Reduced Sales Charges, Additional Exchange and Redemption Information and
Other Services........................................................... 34
Conversion of Class B Shares.............................................. 38
Valuation of Shares....................................................... 39
Performance Information................................................... 40
Taxes..................................................................... 43
Other Information......................................................... 46
Financial Statements...................................................... 47
Appendix.................................................................. 48
</TABLE>
[LOGO OF RECYCLED PAPER APPEARS HERE]
(C) 1995 PAINEWEBBER INCORPORATED
PaineWebber
Utility Income Fund
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Statement of Additional Information
April 1, 1995
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[LOGO OF PAINEWEBBER APPEARS HERE]
