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PAINEWEBBER SHORT-TERM U.S. GOVERNMENT INCOME FUND
1285 AVENUE OF THE AMERICAS
NEW YORK, NEW YORK 10019
STATEMENT OF ADDITIONAL INFORMATION
PaineWebber Short-Term U.S. Government Income Fund ("Fund") is a diversified
series of a professionally managed, open-end management investment company
organized as a Massachusetts business trust ("Trust"). The Fund seeks high
current income consistent with the preservation of capital and low volatility
of net asset value; it invests primarily in mortgage-backed securities that are
issued or guaranteed by the U.S. government, its agencies or instrumentalities
and other U.S. government securities. The Fund's investment adviser,
administrator and distributor is Mitchell Hutchins Asset Management Inc.
("Mitchell Hutchins"), a wholly owned subsidiary of PaineWebber Incorporated
("PaineWebber"). As distributor for the Fund, Mitchell Hutchins has appointed
PaineWebber to serve as the exclusive dealer for the sale of Fund shares. The
Fund's investment sub-adviser is Pacific Investment Management Company
("PIMCO"). 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.
YIELD FACTORS AND RATINGS. Standard & Poor's Ratings Group ("S&P"), Moody's
Investors Service, Inc. ("Moody's") and other nationally recognized statistical
rating organizations ("NRSROs") are private services that provide ratings of
the credit quality of mortgage- and asset-backed securities and other debt
obligations. The Fund may use these ratings in determining whether to purchase,
sell or hold a security.
S&P's highest rating category is AAA. Moody's highest rating category is Aaa.
Publications of S&P indicate that it assigns such ratings to securities for
which the obligor's "capacity to pay interest and repay principal is extremely
strong." Publications of Moody's indicate that it assigns such ratings to
securities that "are judged to be of the best quality" and "carry the smallest
degree of investment risk," that interest payments on such securities "are
protected by a large or by an exceptionally stable margin and principal is
secure" and that 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." The process by which S&P and Moody's determine
ratings for mortgage- and asset-backed securities includes consideration of the
likelihood of the receipt by security holders of all distributions, the nature
of the underlying securities, the credit quality of the guarantor, if any, and
the structural, legal and tax aspects associated with such securities. Neither
of such ratings
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represents an assessment of the likelihood that principal prepayments will be
made by mortgagors or the degree to which such prepayments may differ from that
originally anticipated, nor do such ratings address the possibility that
investors may suffer a lower than anticipated yield or that investors in such
securities may fail to recoup fully their initial investment due to
prepayments.
It should be emphasized that ratings are general and are not absolute
standards of quality. Consequently, debt obligations with the same maturity,
interest rate and rating may have different market prices. Also, rating
agencies 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 would indicate. The rating assigned to a security by a
NRSRO does not reflect an assessment of the volatility of the security's market
value or of the liquidity of an investment in the security. 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. PIMCO will consider such an event in determining whether the Fund should
continue to hold the obligation, but is not required to dispose of it. In
addition to ratings assigned to individual securities, PIMCO will analyze
interest rate trends and developments that may affect individual issuers,
including factors such as liquidity, profitability and asset quality.
The yields on debt securities, including mortgage- and asset-backed
securities in which the Fund invests are dependent on a variety of factors,
including general money market conditions, general conditions in the bond
market, the financial condition of the issuer, the size of the offering, the
maturity of the obligation and its credit rating. There is a wide variation in
the quality of debt securities, both within a particular classification and
between classifications. The obligations of an issuer of debt securities are
subject to the provisions of bankruptcy, insolvency and other laws affecting
the rights and remedies of bond holders or other creditors of an issuer;
litigation or other conditions may also adversely affect the power or ability
of issuers to meet their obligations for the payment of interest and principal.
ADJUSTABLE RATE AND FLOATING RATE MORTGAGE-BACKED SECURITIES. The Fund may
invest in adjustable rate mortgage ("ARM") and floating rate mortgage-backed
securities. Because the interest rates on ARM and floating rate mortgage-backed
securities are reset in response to changes in a specified market index, the
values of such securities tend to be less sensitive to interest rate
fluctuations than the values of fixed-rate securities. As a result, during
periods of rising interest rates, ARMs generally do not decrease in value as
much as fixed rate securities. Conversely, during periods of declining interest
rates, ARMs generally do not increase in value as much as fixed rate
securities. ARM mortgage-backed securities represent a right to receive
interest payments at a rate that is adjusted to reflect the interest earned on
a pool of ARMs. ARMs generally provide that the borrower's mortgage interest
rate may not be adjusted above a specified lifetime maximum rate or, in some
cases, below a minimum lifetime rate. In addition, certain ARMs provide for
limitations on the maximum amount by which the mortgage interest rate may
adjust for any single adjustment period. ARMs also may provide for limitations
on changes in the maximum amount by which the borrower's monthly payment may
adjust for any single adjustment period. In the event that a monthly payment is
not sufficient to pay the interest accruing on the ARM, any such excess
interest is added to the mortgage loan ("negative amortization"), which is
repaid through future monthly payments. If the monthly payment exceeds the sum
of the interest accrued at the applicable
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mortgage interest rate and the principal payment that would have been necessary
to amortize the outstanding principal balance over the remaining term of the
loan, the excess reduces the principal balance of the ARM. Borrowers under ARMs
experiencing negative amortization may take longer to build up their equity in
the underlying property and may be more likely to default.
The rates of interest payable on certain ARMs, and therefore on certain ARM
mortgage-backed securities, are based on indices, such as the one-year constant
maturity Treasury rate ("CMT"), that reflect changes in market interest rates.
Others are based on indices, such as the 11th District Federal Home Loan Bank
Cost of Funds index ("COFI"), that tend to lag behind changes in market
interest rates. The values of ARM mortgage-backed securities supported by ARMs
that adjust based on lagging indices tend to be somewhat more sensitive to
interest rate fluctuations than those reflecting current interest rate levels,
although the values of such ARM mortgage-backed securities still tend to be
less sensitive to interest rate fluctuations than fixed-rate securities.
Floating rate mortgage-backed securities are classes of mortgage-backed
securities that have been structured to represent the right to receive interest
payments at rates that fluctuate in accordance with an index but that generally
are supported by pools comprised of fixed-rate mortgage loans. As with ARM
mortgage-backed securities, interest rate adjustments on floating rate
mortgage-backed securities may be based on indices that lag behind market
interest rates. Interest rates on floating rate mortgage-backed securities
generally are adjusted monthly. Floating rate mortgage-backed securities are
subject to lifetime interest rate caps, but they generally are not subject to
limitations on monthly or other periodic changes in interest rates or monthly
payments.
SPECIAL CHARACTERISTICS OF MORTGAGE-BACKED AND ASSET-BACKED SECURITIES. The
yield characteristics of mortgage- and asset-backed securities differ from
those of traditional debt securities. Among the major differences are that
interest and principal payments are made more frequently, usually monthly, and
that principal may be prepaid at any time because the underlying mortgage loans
or other obligations generally may be prepaid at any time. Prepayments on a
pool of mortgage loans are influenced by a variety of economic, geographic,
social and other factors, including changes in mortgagors' housing needs, job
transfers, unemployment, mortgagors' net equity in the mortgaged properties and
servicing decisions. Generally, however, prepayments on fixed-rate mortgage
loans will increase during a period of falling interest rates and decrease
during a period of rising interest rates. Similar factors apply to prepayments
on asset-backed securities, but the receivables underlying asset-backed
securities generally are of a shorter maturity and thus are less likely to
experience substantial prepayments. Such securities, however, often provide
that for a specified time period the issuers will replace receivables in the
pool that are repaid with comparable obligations. If the issuer is unable to do
so, repayment of principal on the asset-backed securities may commence at an
earlier date. Mortgage- and asset-backed securities may decrease in value as a
result of increases in interest rates and may benefit less than other fixed-
income securities from declining interest rates because of the risk of
prepayment.
ARMs also may be subject to a greater rate of prepayments in a declining
interest rate environment. For example, during a period of declining interest
rates, prepayments on ARMs could increase because the availability of fixed
mortgage loans at competitive interest rates may encourage mortgagors to "lock-
in" at a lower interest rate. Conversely, during a period of rising interest
rates, prepayments on ARMs might decrease. The rate of prepayments with respect
to ARMs has fluctuated in recent years.
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The rate of interest on mortgage-backed securities is lower than the interest
rates paid on the mortgages included in the underlying pool due to the annual
fees paid to the servicer of the mortgage pool for passing through monthly
payments to certificateholders and to any guarantor, and due to any yield
retained by the issuer. Actual yield to the holder may vary from the coupon
rate, even if adjustable, if the mortgage-backed securities are purchased or
traded in the secondary market at a premium or discount. In addition, there is
normally some delay between the time the issuer receives mortgage payments from
the servicer and the time the issuer makes the payments on the mortgage-backed
securities and this delay reduces the effective yield to the holder of such
securities.
Yields on pass-through securities are typically quoted by investment dealers
and vendors based on the maturity of the underlying instruments and the
associated average life assumption. The average life of pass-through pools
varies with the maturities of the underlying mortgage loans. A pool's term may
be shortened by unscheduled or early payments of principal on the underlying
mortgages. Because prepayment rates of individual pools vary widely, it is not
possible to predict accurately the average life of a particular pool. In the
past, a common industry practice has been to assume that prepayments on pools
of fixed rate 30-year mortgages would result in a 12-year average life for the
pool. At present, mortgage pools, particularly those with loans with other
maturities or different characteristics, are priced on an assumption of average
life determined for each pool. In periods of declining interest rates, the rate
of prepayment tends to increase, thereby shortening the actual average life of
a pool of mortgage-related securities. Conversely, in periods of rising
interest rates, the rate of prepayment tends to decrease, thereby lengthening
the actual average life of the pool. However, these effects may not be present,
or may differ in degree, if the mortgage loans in the pools have adjustable
interest rates or other special payment terms, such as a prepayment charge.
Actual prepayment experience may cause the yield of mortgage-backed securities
to differ from the assumed average life yield. Reinvestment of prepayments may
occur at lower interest rates than the original investment, thus adversely
affecting the yield of the Fund.
ILLIQUID SECURITIES. As indicated in the Prospectus, the Fund may invest up
to 15% of its net assets in illiquid securities. The term "illiquid securities"
for this purpose includes, among other things, over-the-counter ("OTC")
options, repurchase agreements maturing in more than seven days and restricted
securities other than those PIMCO has determined are liquid pursuant to
guidelines established by the Trust's board of trustees. Interest-only ("IO")
and principal-only ("PO") mortgage-backed securities are considered illiquid
except that PIMCO may determine that IO and PO classes of fixed-rate mortgage-
backed securities issued by the U.S. government or one of its agencies or
instrumentalities 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 at 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"). 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
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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
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 PIMCO, pursuant to guidelines approved by the
board. PIMCO takes into account a number of factors in reaching liquidity
decisions, including but not limited to (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 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). PIMCO 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 these 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 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
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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 PIMCO to present minimal credit risks in accordance
with guidelines established by the Trust's board of trustees. PIMCO reviews and
monitors the creditworthiness of those institutions under the general
supervision of Mitchell Hutchins and the Trust's board.
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
PIMCO deems it advantageous to do so, which may result in capital gain or loss
to the Fund.
LENDING OF PORTFOLIO SECURITIES. The Fund is authorized to lend up to 10% of
the total value of its portfolio securities to broker-dealers or institutional
investors that PIMCO deems qualified, but only when the borrower maintains with
the Fund's custodian 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,
PIMCO would consider, and during the period of the loan would 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 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 dollar
rolls, 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 or interest rate protection transactions.
INVESTMENT LIMITATIONS. The Fund may not (1) purchase the securities of any
issuer if as a result more than 5% of the total assets of the Fund would be
invested in the securities of that issuer; provided that securities issued or
guaranteed by the U.S. government, its agencies and instrumentalities are not
subject to this limitation and further provided that up to 25% of the value of
the Fund's assets may be invested without regard to this limitation; (2) issue
senior securities or
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borrow money, except from banks or through reverse repurchase agreements and
mortgage dollar rolls, and then in an aggregate amount not in excess of 33 1/3%
of the Fund's total assets (including the amount of the borrowings and senior
securities issued but reduced by any liabilities not constituting senior
securities) at the time of such borrowings, except that the Fund may borrow up
to an additional 5% of total assets (not including the amount borrowed) for
temporary or emergency purposes; (3) purchase securities if, as a result of the
purchase, the Fund would have more than 25% of the value of its total assets
invested in securities of issuers in any one industry, except that this
limitation does not apply to (a) obligations issued or guaranteed by the U.S.
government, its agencies and instrumentalities and (b) investments in mortgage-
and asset-backed securities, which (whether or not issued or guaranteed by an
agency or instrumentality of the U.S. government) shall be considered a single
industry for purposes of this limitation; (4) underwrite 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; (5) purchase or sell real estate (including real estate
limited partnerships), except that investments in mortgage-backed securities
and other debt securities secured by real estate or interests therein are not
subject to this limitation, and provided further that the Fund may exercise
rights under agreements relating to such securities, including the right to
enforce security interests and to liquidate real estate acquired as a result of
such enforcement; (6) purchase securities on margin, make short sales of
securities or maintain a short position in any security, except that the Fund
may (a) make margin deposits, make short sales and maintain short positions in
connection with its use of options, futures contracts and options on futures
contracts and (b) sell short "against the box"; (7) purchase or sell
commodities or commodity contracts, except that the Fund may purchase or sell
financial futures contracts, such as interest rate and bond index futures
contracts and options thereon; (8) invest in oil, gas or mineral exploration or
development programs or leases, except that the Fund may invest in issuers
which invest in such programs; (9) purchase securities of other open-end
investment companies, except in connection with a merger, consolidation or
acquisition; or (10) make loans, except through repurchase agreements and
except in connection with the loan of securities as described herein or in the
Prospectus; provided that for purposes of this restriction the acquisition of
bonds or other debt instruments, or interests therein, 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 (a) more than 50% of the outstanding
shares of the Fund or (b) 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. For purposes of fundamental investment limitation (1), mortgage-
and asset-backed securities will not be considered to have been issued by the
same issuer by reason of such securities having the same sponsor, and mortgage-
and asset-backed securities issued by a finance subsidiary or other single
purpose subsidiary of a corporation that are not guaranteed by the parent
corporation will be considered to be issued by a separate issuer from its
parent corporation.
The following investment restrictions are non-fundamental and may be changed
by the vote of the Trust's board of trustees without shareholder approval: the
Fund may not (1) purchase or retain the securities of any issuer if, to the
knowledge of the Fund's management, the officers and trustees
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of the Trust and the officers and directors of Mitchell Hutchins and PIMCO
(each owning beneficially as principal for its own account more than 0.5% of
the outstanding securities of the issuer) beneficially so own in the aggregate
more than 5% of the securities of the issuer; (2) purchase any security, other
than mortgage- and asset-backed securities if as a result more than 5% of the
Fund's total assets would be invested in securities of companies that together
with any predecessors have been in continuous operation for less than three
years; (3) invest more than 15% of its net assets in illiquid securities, a
term that 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 and (4) invest in warrants, valued at the
lower of cost or market, in excess of 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 unlisted
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.
HEDGING AND RELATED INCOME STRATEGIES
GENERAL DESCRIPTION OF HEDGING STRATEGIES. As discussed in the Prospectus,
PIMCO may use a variety of financial instruments ("Hedging Instruments"),
including certain options, futures contracts (sometimes referred to as
"futures") and options on futures contracts, to attempt to hedge the Fund's
portfolio and to enhance income. PIMCO also may attempt to hedge the Fund's
portfolio through the use of interest rate protection transactions. The
particular Hedging Instruments are described in Appendix B 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 that 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 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.
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The Fund may purchase and write (sell) covered straddles on securities or
indices of debt securities. 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 PIMCO believes it
likely that interest rates will be more volatile during the term of the option
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 it unlikely that interest
rates will be as volatile during the term of the option 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 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
Securities and Exchange Commission ("SEC"), the several options and futures
exchanges upon which they are traded, the Commodity Futures Trading Commission
("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, PIMCO expects to discover additional opportunities in connection
with options, futures contracts and other hedging techniques. These new
opportunities may become available as PIMCO develops new techniques, as
regulatory authorities broaden the range of permitted transactions and as new
options, futures contracts or other techniques are developed. PIMCO 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 PIMCO's
ability to predict movements of the overall securities and interest rate
markets, which requires different skills than predicting changes in the
prices of individual securities. While PIMCO is experienced in the use of
Hedging Instruments, there can be no assurance that any particular hedging
strategy adopted will succeed.
(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.
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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
into a short hedge because PIMCO 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 or other options or futures
contracts or (2) cash, receivables 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 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 debt securities. The purchase of call options serves
as a long hedge, and the purchase of put options serves as a short hedge.
Writing covered put or call options can enable the Fund to
10
<PAGE>
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 security underlying a covered put option declines to less than the exercise
price on the option, minus the premium received, the Fund would expect to
suffer a loss. 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 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 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, OTC options on debt securities 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 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 a contra party (usually a securities dealer or a
bank) with no clearing organization guarantee. Thus, when the Fund purchases or
writes an OTC option, 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
11
<PAGE>
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.
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 and debt security indices and options on future 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 interest rate futures contracts and
debt security index futures contracts. The Fund may also purchase put and call
options, and write covered put and call options, on such futures contracts. 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, and writing covered put options on futures contracts can serve as
a limited long hedge, using a strategy similar to that used for writing covered
call or put options on securities or indices.
Futures strategies also can be used to manage the average duration of the
Fund's portfolio. If PIMCO wishes to shorten the average duration of the Fund,
the Fund may sell an interest rate or debt security index futures contract or a
call option thereon, or purchase a put option on that futures contract. If
PIMCO wishes to lengthen the average duration of the Fund, the Fund may buy an
interest rate or debt security index futures contract or a call option thereon
or sell a put option thereon.
The Fund may also write put options on interest rate futures contracts 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 purchasing the
futures contract.
12
<PAGE>
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 a call 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.
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
13
<PAGE>
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 and options on
futures positions 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 and debt security 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.
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, respectively, 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 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 or goes
below a designated floor 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
14
<PAGE>
inasmuch as segregated accounts will be established with respect to such
transactions, PIMCO and the Fund believe such obligations do not constitute
senior securities and, accordingly, will not treat them as being subject to its
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 PIMCO 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 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.
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 BUSINESS EXPERIENCE;
NAME, AGE AND ADDRESS* WITH TRUST OTHER DIRECTORSHIPS
- ---------------------- ---------- --------------------
<S> <C> <C>
E. Garrett Bewkes, Jr.; Trustee and Chairman Mr. Bewkes is a director of Paine
68** of the Board of Webber Group Inc. ("PW Group")
Trustees (holding company of PaineWebber
and Mitchell Hutchins) and a con-
sultant to PW Group. Prior to
1988, he was chairman of the
board, president and chief execu-
tive officer of American Bakeries
Company. Mr. Bewkes is also a di-
rector of Interstate Bakeries
Corporation and NaPro
BioTherapeutics, Inc. and a di-
rector or trustee of 26 other in-
vestment companies for which
Mitchell Hutchins or PaineWebber
serves as investment adviser.
</TABLE>
15
<PAGE>
<TABLE>
<CAPTION>
POSITION BUSINESS EXPERIENCE;
NAME, AGE AND ADDRESS* WITH TRUST OTHER DIRECTORSHIPS
- ---------------------- ---------- --------------------
<S> <C> <C>
Meyer Feldberg; 52 Trustee Mr. Feldberg is Dean and Professor
Columbia University of Management of the Graduate
101 Uris Hall School of Business, Columbia Uni-
New York, New York 10027 versity. Prior to 1989, he was
president of the Illinois Insti-
tute of Technology. Dean Feldberg
is also a director of AMSCO In-
ternational Inc., Federated De-
partment Stores, Inc., Inco Homes
Corporation and New World Commu-
nications Group Incorporated and
a director or trustee of 18 other
investment companies for which
Mitchell Hutchins or PaineWebber
serves as investment adviser.
George W. Gowen; 65 Trustee Mr. Gowen is a partner in the law
666 Third Avenue firm of Dunnington, Bartholow &
New York, New York 10017 Miller. Prior to May 1994, he was
a partner in the law firm of Fry-
er, Ross & Gowen. 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>
16
<PAGE>
<TABLE>
<CAPTION>
POSITION BUSINESS EXPERIENCE;
NAME, AGE AND ADDRESS* WITH TRUST OTHER DIRECTORSHIPS
- ---------------------- ---------- --------------------
<S> <C> <C>
Frederic V. Malek; 58 Trustee Mr. Malek is chairman of Thayer
901 15th Street, N.W. Capital Partners (investment
Suite 300 bank) and a co-chairman and di-
Washington, D.C. 20005 rector of CB Commercial 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 North-
west Airlines Inc., NWA Inc.
(holding company of Northwest
Airlines Inc.) and Wings Holdings
Inc. (holding company of NWA
Inc.). Prior to January 1989, he
was employed by the Marriott Cor-
poration (hotels, restaurants,
airline catering and contract
feeding), where he most recently
was an executive vice president
and president of Marriott Hotels
and Resorts. Mr. Malek is also a
director of American Management
Systems, Inc., Automatic Data
Processing, Inc., Avis, Inc., FPL
Group, Inc., ICF International,
Manor Care, Inc., National Educa-
tion Corporation and Northwest
Airlines Inc. and a director or
trustee of 16 other investment
companies for which Mitchell
Hutchins or PaineWebber serves as
investment 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 Institu-
tional Investors Inc. and a di-
rector of PaineWebber. Prior to
1993, Mr. Minard was managing di-
rector of Oppenheimer Capital in
New York and director of Oppen-
heimer Capital 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>
17
<PAGE>
<TABLE>
<CAPTION>
POSITION BUSINESS EXPERIENCE;
NAME, AGE AND ADDRESS* WITH TRUST OTHER DIRECTORSHIPS
- ---------------------- ---------- --------------------
<S> <C> <C>
Judith Davidson Moyers; Trustee Mrs. Moyers is president of Public
59 Affairs Television, Inc., an edu-
Public Affairs cational consultant and a home
Television economist. Mrs. Moyers is also a
356 W. 58th Street director of Ogden Corporation and
New York, New York 10019 a director 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
400 Park Avenue financial consultant. Mr. Murray
New York, New York 10022 is also a director and chairman
of American Continental Proper-
ties, Inc., a trustee of Pruden-
tial Realty Trust and a director
or trustee of 16 other investment
companies for which Mitchell
Hutchins or PaineWebber serves as
investment adviser.
Teresa M. Boyle; 36 Vice President Ms. Boyle is a first vice presi-
dent and manager--advisory admin-
istration of Mitchell Hutchins.
Prior to November 1993, she was
compliance manager of Hyperion
Capital Management, Inc., an in-
vestment advisory firm. Prior to
April 1993, Ms. Boyle was a vice
president and manager--legal ad-
ministration of Mitchell
Hutchins. Ms. Boyle is also a
vice president of 39 other in-
vestment 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
Assistant Secretary attorney 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 assis-
tant secretary of 26 other in-
vestment companies for which
Mitchell Hutchins or PaineWebber
serves as investment adviser.
</TABLE>
18
<PAGE>
<TABLE>
<CAPTION>
NAME, AGE AND POSITION BUSINESS EXPERIENCE;
ADDRESS* WITH TRUST OTHER DIRECTORSHIPS
- ------------- ---------- --------------------
<S> <C> <C>
Ellen R. Harris; 48 Vice President Ms. Harris is chief domestic eq-
uity strategist and a managing
director of Mitchell Hutchins.
Ms. Harris is also a vice presi-
dent of 19 other investment com-
panies for which Mitchell
Hutchins or PaineWebber serves as
investment adviser.
Mary B. King; 31 Vice President Mrs. King is a first vice presi-
dent and a portfolio manager of
Mitchell Hutchins. Mrs. King is
also a vice president of one
other investment company for
which Mitchell Hutchins serves as
investment adviser.
Thomas J. Libassi; 36 Vice President Mr. Libassi is a senior vice pres-
ident of Mitchell Hutchins. Prior
to May 1994, he was a vice presi-
dent of Keystone Custodian Funds
Inc. with portfolio 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 and Ms. Moran is a vice president of
Assistant Treasurer Mitchell Hutchins. Ms. Moran is
also a vice president and assis-
tant treasurer of 39 other in-
vestment companies for which
Mitchell Hutchins or PaineWebber
serves as investment adviser.
</TABLE>
19
<PAGE>
<TABLE>
<CAPTION>
POSITION BUSINESS EXPERIENCE;
NAME, AGE AND ADDRESS* WITH TRUST OTHER DIRECTORSHIPS
- ---------------------- ---------- --------------------
<S> <C> <C>
Dianne E. O'Donnell; 42 Vice President and Ms. O'Donnell is a senior vice
Secretary president 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.
Victoria E. Schonfeld; 44 Vice President Ms. Schonfeld is a managing direc-
tor and general counsel of Mitch-
ell 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, Hoffman &
Goodman. Ms. Schonfeld is also a
vice president of 39 other in-
vestment companies for which
Mitchell Hutchins or PaineWebber
serves as investment adviser.
Paul H. Schubert; 32 Vice President and Mr. Schubert is a vice president
Assistant Treasurer of Mitchell Hutchins. From August
1992 to August 1994, he was a
vice president at BlackRock Fi-
nancial Management, L.P. Prior to
August 1992, he was an audit man-
ager with Ernst & Young LLP. Mr.
Schubert is also a vice president
and assistant treasurer of 39
other investment companies for
which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
Martha J. Slezak; 32 Vice President and Ms. Slezak is a vice president of
Assistant Treasurer Mitchell Hutchins. From September
1991 to April 1992, she was
fundraising director for a U.S.
Senate campaign. Prior to Septem-
ber 1991, she was a tax manager
with Arthur Andersen & Co. LLP.
Ms. Slezak is also a vice presi-
dent and assistant treasurer of
39 other investment companies for
which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
</TABLE>
20
<PAGE>
<TABLE>
<CAPTION>
POSITION BUSINESS EXPERIENCE;
NAME, AGE AND ADDRESS* WITH TRUST OTHER DIRECTORSHIPS
- ---------------------- ---------- --------------------
<S> <C> <C>
Julian F. Sluyters; 34 Vice President and Mr. Sluyters is a senior vice
Treasurer president 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 invest-
ment companies for which Mitchell
Hutchins or PaineWebber serves as
investment adviser.
Gregory K. Todd; 38 Vice President and Mr. Todd is a first vice president
Assistant Secretary and 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 assistant 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
also are 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, 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.
21
<PAGE>
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
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 28, 1988, as supplemented by a separate fee agreement dated March
26, 1993, ("Advisory Contract"). Under the Advisory Contract, the Fund pays
Mitchell Hutchins an annual fee of 0.50% of the Fund's average net assets,
computed daily and paid monthly. During the fiscal year ended November 30,
1994, the Fund paid (or accrued) to Mitchell Hutchins investment advisory and
administrative fees of $5,598,491 of which $400,611 was waived by Mitchell
Hutchins. During the period May 3, 1993 (commencement of operations) to
November 30, 1993, the Fund paid (or accrued) to Mitchell Hutchins investment
advisory and administrative fees of $3,519,442.
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. During the
fiscal year ended November 30, 1994 and the period May 3, 1993 (commencement of
operations) to November 30, 1993, PaineWebber earned fees under the service
agreement in the amount of $139,291 and $71,854, respectively.
22
<PAGE>
The Advisory Contract authorizes Mitchell Hutchins to retain one or more sub-
advisers but does not require Mitchell Hutchins to do so. Under a sub-
investment advisory contract ("Sub-Advisory Contract") dated November 14, 1994
with Mitchell Hutchins, PIMCO serves as sub-adviser for the Fund. Under the
Sub-Advisory Contract, Mitchell Hutchins (not the Fund) pays PIMCO a fee in the
annual amount of 0.25% of the Fund's average daily net assets. PIMCO bears all
expenses incurred by it in connection with its services under the Sub-Advisory
Contract. For the period October 20, 1994 to November 30, 1994, Mitchell
Hutchins paid (or accrued) to PIMCO sub-advisory fees of $147,540 pursuant to
the Sub-Advisory Contract and a prior substantially similar contract.
Under the terms of the Advisory Contract, the Fund will bear 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 a particular series of the Trust are allocated among the series (including
the Fund) by or under the direction of the Trust's board of trustees in such
manner as the board deems 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 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 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 any other insurance or fidelity bonds; (9)
any costs, expenses or losses 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 existing 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 Fund if
and to the extent that the aggregate operating expenses of the Fund in any
fiscal year exceed applicable limits. 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 and extraordinary items, are excluded from this limitation. No
reimbursement pursuant to such limitation was required for the fiscal year
ended November 30, 1994.
23
<PAGE>
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 Trust or
the Fund in connection with the performance of the Advisory Contract, except to
the extent that such loss results 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 obligations and duties thereunder. Under the
Sub-Advisory Contract, PIMCO will not be liable for any error of judgment or
mistake of law or for any loss suffered by the Trust, the Fund, its
shareholders or Mitchell Hutchins in connection with the Sub-Advisory Contract,
except any liability to the Trust, the Fund, its shareholders or Mitchell
Hutchins to which PIMCO would otherwise be subject by reason of willful
misfeasance, bad faith, gross negligence on its part in the performance of its
duties or from reckless disregard by it of its obligations and duties under the
Sub-Advisory Contract. The Advisory Contract terminates automatically upon
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 Sub-Advisory
Contract terminates automatically upon its assignment or the termination of the
Advisory Contract and is terminable at any time without penalty by the board of
trustees or by vote of the holders of a majority of the Fund's outstanding
voting securities on 60 days' notice to PIMCO, or by PIMCO on 120 days' written
notice to Mitchell Hutchins. The Sub-Advisory Contract may also be terminated
by Mitchell Hutchins (1) upon material breach by PIMCO of its representations
and warranties, which breach shall not have been cured within a 20 day period
after notice of such breach; (2) if PIMCO becomes unable to discharge its
duties and obligations under the Sub-Advisory Contract or (3) on 120 days'
notice to PIMCO.
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 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, Mitchell
Hutchins 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.
24
<PAGE>
PIMCO personnel also may invest in securities for their own accounts pursuant
to PIMCO's code of ethics which establishes procedures for personal investing
and restricts certain transactions.
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 businesses, to sell shares of the Fund. Shares of the Fund are
offered continuously. Under separate exclusive dealer agreements between
Mitchell Hutchins and PaineWebber 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 Fund shares. Under the Class B Plan, the Fund
also pays Mitchell Hutchins a monthly distribution fee at the annual rate of
0.75% of the average daily net assets of the Class B shares. Under the Class D
Plan, the Fund pays Mitchell Hutchins a monthly distribution fee, accrued daily
and payable monthly, at the annual rate of 0.50% of the average daily net
assets of the Class D shares.
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 Fund's outstanding
voting securities 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 shares 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..................................... $ 889,441
Class B..................................... $ 258,627
Class D..................................... $5,505,447
</TABLE>
25
<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............................................ $ 554,268
Printing of prospectuses and statements of additional information.... 2,159
Branch network costs allocated and interest expense.................. 2,616,074
Service fees paid to PaineWebber investment executives............... 404,748
<CAPTION>
CLASS B
-------
<S> <C>
Marketing and advertising............................................ $ 19,602
Amortization of commissions.......................................... 193,753
Printing of prospectuses and statements of additional information.... 51
Branch network costs allocated and interest expense.................. 123,423
Service fees paid to PaineWebber investment executives............... 29,096
<CAPTION>
CLASS D
-------
<S> <C>
Marketing and advertising............................................ $ 562,272
Amortization of commissions.......................................... 2,616,723
Printing of prospectuses and statements of additional information.... 12,648
Branch network costs allocated and interest expense.................. 3,342,930
Service fees paid to PaineWebber investment executives............... 825,816
</TABLE>
"Marketing and advertising" includes various internal costs allocated by
Mitchell Hutchins to its efforts at 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
the Fund's shares, including the PaineWebber retail branch system.
In approving the Fund's overall Flexible Pricing SM 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 best suited to their individual situation, thereby
encouraging existing 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 load 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
26
<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 the Fund's 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 also considered the
benefits that would accrue to Mitchell Hutchins under each Plan in that
Mitchell
27
<PAGE>
Hutchins would receive service, distribution and advisory fees which 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, for the periods set forth below, Mitchell Hutchins earned
the following approximate amounts in sales charges and retained the following
approximate amounts, net of concessions to PaineWebber as exclusive dealer.
<TABLE>
<CAPTION>
FOR THE PERIOD
FOR YEAR ENDED MAY 3, 1993*
NOVEMBER 30, 1994 TO NOVEMBER 30, 1993
----------------- --------------------
<S> <C> <C>
Earned................................ $892,216 $5,336,484
Retained.............................. 494,591 31,294
</TABLE>
- --------
* Commencement of operations.
For the fiscal year ended November 30, 1994, Mitchell Hutchins earned and
retained approximately $251,254 in contingent deferred sales charges paid upon
certain redemptions of Class B shares.
PORTFOLIO TRANSACTIONS
Subject to policies established by the board of trustees of the Trust, PIMCO
is responsible for the execution of the Fund's portfolio transactions and the
allocation of brokerage transactions. In executing portfolio transactions,
PIMCO 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. Generally, bonds are traded on the OTC market
on a "net" basis without a stated commission through dealers acting for their
own account and not as brokers. Prices paid to dealers in principal
transactions 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. While PIMCO 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. During the fiscal
year ended November 30, 1994 and the period May 3, 1993 (commencement of
operations) to November 30, 1993, the Fund paid $88,421 and $0, 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 or 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 authorize Mitchell
Hutchins and any of its affiliates to retain compensation in connection with
such transactions. Any such transactions will
28
<PAGE>
be effected and related compensation paid only in accordance with applicable
regulations of the SEC. During the fiscal year ended November 30, 1994 and the
period May 3, 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 interests of the Fund and subject to the review of the
Trust's board of trustees, PIMCO may, in its discretion, use brokers who
provide the Fund with research, analysis, advice and similar services to
execute portfolio transactions on behalf of the Fund. In return for such
services, the Fund may pay to those brokers a higher commission than may be
charged by other brokers, provided that PIMCO determines in good faith that
such commission is reasonable in terms either of that particular transaction or
of the overall responsibility of PIMCO 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, PIMCO seeks best execution.
Although PIMCO may receive certain research or execution services in connection
with these transactions, PIMCO 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,
PIMCO 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. PIMCO may engage in
agency transactions in OTC 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 PIMCO
receiving multiple quotes from dealers before executing the transaction on an
agency basis.
Research services furnished by brokers or dealers with or through which the
Fund effects securities transactions may be used by PIMCO in advising other
funds or accounts it manages and, conversely, research services furnished to
PIMCO in connection with other funds or accounts it manages may be used by
PIMCO for 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
PIMCO under the Sub-Advisory Contract. During the fiscal year ended November
30, 1994 and the period May 3, 1993 (commencement of operations) to November
30, 1993, neither Mitchell Hutchins nor PIMCO directed portfolio transactions
to brokers chosen because they provided research services. The Fund may
purchase and sell securities to and from dealers who provide the Fund with
research services. Portfolio transactions will not be directed by the Fund to
such dealers when they are acting as principals 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 PIMCO in
advising other funds or accounts, and, conversely, research services furnished
to PIMCO in connection with other funds or accounts that PIMCO advises may be
used in advising the Fund.
29
<PAGE>
Investment decisions for the Fund and for other investment accounts managed
by PIMCO 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 spread or commission paid in
connection with such a purchase be reasonable and fair, 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 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. During the fiscal year ended
November 30, 1994 and the period May 3, 1993 (commencement of operations) to
November 30, 1993, the portfolio turnover rate for the Fund was 246.34% and
96.60%, respectively. The Fund's high portfolio turnover rate for the fiscal
year ended November 30, 1994 was attributable to repositioning caused by an
unusually high number of redemptions.
30
<PAGE>
REDUCED SALES CHARGES, ADDITIONAL EXCHANGE AND REDEMPTION
INFORMATION AND OTHERSERVICES
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 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);
(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 individual 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.
31
<PAGE>
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 the Fund's investment objective, policies and
restrictions.
If conditions exist that 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. Any such
redemptions in kind will be made with readily marketable securities, to the
extent available. 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 systematic
withdrawal
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<PAGE>
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 reinstatement privilege is
exercised within 30 days after redemption, and an adjustment will be made to
the shareholder's tax basis for 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.
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
client'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.
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<PAGE>
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:
. 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 accountholders'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 from RMA Service Center;
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<PAGE>
. 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 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 values per share of each of the two Classes, as
of the close of business on the first Business Day (as defined under "Valuation
of Shares") 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. If a shareholder
acquired Class B shares of the Fund through an exchange of Class B shares of a
CDSC Fund that were acquired prior to July 1, 1991, the shareholder's holding
period for purposes of conversion will be determined based on the date the CDSC
Fund shares were initially issued. For purposes of conversion into Class A
shares, Class B shares purchased through the reinvestment of dividends and
other distributions paid in respect of Class B shares are 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 shares, a pro rata
portion of the Class B shares in the sub-account also converts to Class A
shares. The portion is determined by the ratio that the shareholder's Class B
shares converting to Class A shares 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
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<PAGE>
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.
Where market quotations are readily available, portfolio securities are
valued based upon market quotations, provided such quotations adequately
reflect, in the judgment of PIMCO, the fair value of the security. Where such
market quotations are not readily available, securities are valued at fair
value as determined in good faith by or under the direction of the Trust's
board of trustees, generally based upon appraisals received from a pricing
service using a computerized matrix system or derived from information
concerning the security or similar securities received from recognized dealers
in those securities. The amortized cost method of valuation generally is used
with respect to debt obligations with 60 days or less remaining until maturity
unless the Trust's board of trustees determines that this does not represent
fair value.
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 shares 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 3% 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
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<PAGE>
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 those 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.
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*............................... (4.50)% (5.24)% (4.99)%
Non-Standardized Return............................ (7.48)% (7.48)% (4.99)%
Inception** to November 30, 1993:
Standardized Return*............................... (3.66)% (4.39)% (2.21)%
Non-Standardized Return............................ (1.72)% (2.45)% (2.21)%
</TABLE>
- --------
* All Standardized Return figures for Class A shares reflect deduction of the
current maximum sales charge of 3%. All Standardized Return figures for Class
B shares reflect deduction of the applicable contingent deferred sales
charges imposed on a redemption of shares held for the period. Class D shares
do not impose an initial or a contingent deferred sales charge; therefore,
Non-Standardized Return is identical to Standardized Return.
** The inception date for each Class of shares is May 3, 1993.
YIELD. Yields used in the Fund's Performance Advertisements are calculated by
dividing the Fund's 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
semiannual 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:
YIELD
= 2[(a-b + 1)/6/ - 1]
cd
<TABLE>
<C> <C> <S>
where: a = 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 the 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.
</TABLE>
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<PAGE>
Except as noted below, in determining net investment income earned during the
Period (variable "a" in the above formula), the Fund calculates interest earned
on each debt obligation held by it during 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 3% initial sales charge on Class A shares
is included.
The following table shows the yield for the Class A, Class B and Class D
shares of the Fund for the 30-day period ended November 30, 1994:
<TABLE>
<CAPTION>
YIELD
-----
<S> <C>
Class A............................................................ 5.36%
Class B............................................................ 4.73%
Class D............................................................ 4.98%
</TABLE>
OTHER INFORMATION. In Performance Advertisements, the Fund may compare its
Standardized Return and/or its Non-Standardized Return with, or otherwise
discuss data (including average 30-day money market fund yields), published by
Lipper Analytical Services, Inc. ("Lipper"); IBC/Donaghue's Money Market Fund
Report; CDA Investment Technologies, Inc. ("CDA"); Wiesenberger Investment
Companies Service ("Wiesenberger"); Investment Company Data Inc. ("ICD"); or
Morningstar Mutual Funds ("Morningstar"); or with the performance of U.S.
Treasury securities of various maturities, recognized stock, bond and other
indices, including (but not limited to) the Salomon Brothers Bond Index,
Shearson Lehman Bond Index, Shearson Lehman Government/Corporate Bond Index,
the Standard & Poor's 500 Composite Stock Price Index, the Dow Jones Industrial
Average, and changes in the Consumer Price Index as published by the U.S.
Department of Commerce. Such comparisons also may include economic data and
statistics published by the United States Bureau of Labor Statistics, such as
the cost of living index, information and statistics on the residential
mortgage market or the market for mortgage-backed securities, such as those
published by the Federal Reserve Bank, the Office of Thrift Supervision, Ginnie
Mae, Fannie Mae and Freddie Mac, and the Lehman Mortgage-Backed Securities
Index. 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. 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
38
<PAGE>
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
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, or may otherwise discuss, the
performance of bank certificates of deposit ("CDs") as measured by the CDA
Investment Technologies, Inc. Certificate of Deposit Index, 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 or its
performance to CDs investors should keep in mind that bank CDs are insured in
whole or in 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. Shares of the Fund are not insured or guaranteed by the U.S. government
and returns and net asset value will fluctuate. In comparing the Fund or its
performance to money market funds, investors should keep in mind that money
market funds seek to maintain a constant net asset value per share of $1.00,
while the net asset value of the Fund's shares will fluctuate and the Fund may
not be able to return money invested on a dollar-for-dollar basis. The
securities held by the Fund generally will have longer maturities than those
held by money market funds or 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 and net short-
term capital gain) ("Distribution Requirement") and must meet several
additional requirements. Among these requirements are 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 other income (including gains
from options or futures) derived with respect to its business of investing in
securities ("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, options or futures that were held for less than three months
("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 (4) at the close of each quarter of the Fund's taxable year,
not more than 25% of the value of its
39
<PAGE>
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 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 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. The Fund
invests exclusively in debt securities and receives no dividend income;
accordingly, no portion of the dividends or other distributions paid by the
Fund will be eligible for the dividends-received deduction allowed to
corporations.
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 shareholder will
pay full price for the shares and receive some portion of the price back as a
taxable distribution.
The Fund will be subject to a nondeductible 4% excise tax to the extent it
fails to distribute by the end of any calendar year substantially all of its
ordinary income for the year and capital gain net income for the one-year
period ending on November 30 of that year, plus certain other amounts.
The use of hedging and option income strategies, such as writing (selling)
and purchasing options and futures contracts, involves complex rules that will
determine for income tax purposes the character and timing of recognition of
the gains and losses the Fund realizes in connection therewith. Income from
transactions in options and futures contracts derived by the Fund with respect
to its business of investing in securities will qualify as permissible income
under the Income Requirement. However, income from the disposition of options
and futures contracts 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 and
futures 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.
The Fund may acquire zero coupon or other securities issued with original
issue discount ("OID"). As the holder of such securities, the Fund would have
to include in its gross income the OID that accrues on the securities during
the taxable year, even if the Fund receives no corresponding payment on the
securities during the year. The Fund intends to elect similar treatment with
respect to securities purchased at a discount from their face value ("market
discount"). Because the Fund annually seeks to distribute substantially all of
its investment company
40
<PAGE>
taxable income, including any accrued OID, market discount and other non-cash
income, in order to continue to satisfy the Distribution Requirement and to
avoid imposition of the 4% excise tax, the Fund may be required in a particular
year to distribute as a dividend an amount that is greater than the total
amount of cash it actually receives. Those distributions will be made from the
Fund's cash assets or from the proceeds of sales of portfolio securities, if
necessary. The Fund may realize capital gains or losses from those sales, which
would increase or decrease the Fund's investment company taxable income or net
capital gain (the excess of net long-term capital gain over net short-term
capital loss). In addition, any such gains may be realized on the disposition
of securities held for less than three months. Because of the Short-Short
Limitation, any such gains would reduce the Fund's ability to sell other
securities, or certain options or futures, held for less than three months that
it might wish to sell in the ordinary course of its portfolio management.
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 could, under certain circumstances, be held
personally liable for the obligations of the Trust or 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 shareholder held personally
liable for the obligations of the Fund. Thus, the risk of a shareholder's
incurring financial loss on account of shareholder liability is limited to
circumstances in which the Fund itself would be unable to meet its obligations,
a possibility that 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 operations of the Fund in such a way as to avoid, as far
as possible, ultimate liability of the shareholders for liabilities of the
Fund.
The Fund is authorized to issue Class C shares in addition to Class A, Class
B and Class D shares, but the Trust's board of trustees has no current
intention of doing so. Class C shares, if issued, would bear no service or
distribution fees, would be sold with no initial sales charge and would be
redeemable at net asset value without the imposition of a contingent deferred
sales charge. Class C shares would be offered only to a limited class of
institutional purchasers.
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 of the Fund bear higher transfer agency fees per shareholder account
than those borne by Class A or Class D 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
41
<PAGE>
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 Prospectus. Kirkpatrick & Lockhart LLP also acts
as counsel to PaineWebber and Mitchell Hutchins in connection with other
matters.
INDEPENDENT AUDITORS. Ernst & Young LLP, 787 Seventh Avenue, New York, N.Y.
10019, serves as independent auditors for the Trust.
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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<PAGE>
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY IN- FORMATION OR TO MAKE ANY REPRE-
SENTATIONS 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 THE DISTRIBUTOR IN ANY JURISDICTION IN WHICH SUCH OFFERING MAY NOT LAW-
FULLY BE MADE.
---------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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<S> <C>
Investment Policies and Restrictions...................................... 1
Hedging and Related Income Strategies..................................... 8
Trustees and Officers..................................................... 15
Investment Advisory and Distribution Arrangements......................... 22
Portfolio Transactions.................................................... 28
Reduced Sales Charges, Additional Exchange and Redemption Information and
Other Services........................................................... 31
Conversion of Class B Shares.............................................. 35
Valuation of Shares....................................................... 35
Performance Information................................................... 36
Taxes..................................................................... 39
Other Information......................................................... 41
Financial Statements...................................................... 42
</TABLE>
(C) 1995 PaineWebber Incorporated
[LOGO OF RECYCLED PAPER APPEARS HERE]
PAINEWEBBER
SHORT-TERM
U.S. GOVERNMENT
INCOME FUND
- ------------------------------------
Statement of Additional Information
April 1, 1995
- ------------------------------------
[LOGO OF PAINEWEBBER APPEARS HERE]
