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PAINEWEBBER U.S. GOVERNMENT INCOME FUND
PAINEWEBBER LOW DURATION U.S. GOVERNMENT INCOME FUND
PAINEWEBBER INVESTMENT GRADE INCOME FUND
PAINEWEBBER HIGH INCOME FUND
1285 AVENUE OF THE AMERICAS
NEW YORK, NEW YORK 10019
STATEMENT OF ADDITIONAL INFORMATION
The four Funds named above (each a "Fund") are diversified series of
PaineWebber Managed Investments Trust ("Trust"), a professionally managed
mutual fund. PaineWebber U.S. Government Income Fund ("U.S. Government Income
Fund") seeks to provide high current income consistent with the preservation of
capital and liquidity; it invests primarily in U.S. government securities.
PaineWebber Low Duration U.S. Government Income Fund ("Low Duration Income
Fund") seeks the highest level of current income consistent with the
preservation of capital and low volatility of net asset value; it invests
primarily in U.S. government securities and seeks to limit the volatility of
its net asset value per share by maintaining, under normal circumstances, an
overall portfolio duration of from one to three years. PaineWebber Investment
Grade Income Fund ("Investment Grade Income Fund") seeks to provide high
current income consistent with the preservation of capital and liquidity; it
invests primarily in investment grade corporate bonds and other fixed income
securities. PaineWebber High Income Fund ("High Income Fund") seeks to provide
the highest level of current income available without undue risk; it invests
primarily in high risk, high yielding medium and lower quality corporate bonds.
The Funds' 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 Funds,
Mitchell Hutchins has appointed PaineWebber to serve as exclusive dealer for
the sale of Fund shares. Pacific Investment Management Company ("PIMCO") serves
as investment sub-adviser for Low Duration Income Fund. This Statement of
Additional Information is not a prospectus and should be read only in
conjunction with the Funds' current Prospectus, dated April 1, 1996, as revised
May 3, 1996. 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,
1996, as revised May 3, 1996.
INVESTMENT POLICIES AND RESTRICTIONS
The following supplements the information contained in the Prospectus
concerning the investment policies and limitations of the Funds.
YIELD FACTORS AND RATINGS. Standard & Poor's, a division of The McGraw Hill
Companies, Inc. ("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
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debt obligations. A description of the ratings assigned to debt obligations by
S&P and Moody's is included in Appendix B to the Prospectus. 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. Not even the highest such ratings
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.
A Fund may use these ratings in determining whether to purchase, sell or hold
a security. It should be emphasized, however, 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 indicates. 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 any 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
that Fund.
In addition to ratings assigned to individual bond issues, Mitchell Hutchins
or PIMCO, as applicable, will analyze interest rate trends and developments
that may affect individual issuers, including factors such as liquidity,
profitability and asset quality. The yields on bonds and other debt securities
in which the Funds invest 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 rating. There is a wide variation in the quality of
bonds, both within a particular classification and between classifications. An
issuer's obligations under its bonds 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 on their bonds.
SPECIAL CHARACTERISTICS OF MORTGAGE- 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,
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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.
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 a Fund.
U.S. Government Income Fund, Low Duration Income Fund and Investment Grade
Income Fund each 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 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
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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 payments. If the monthly payment exceeds the sum of the
interest accrued at the applicable 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, 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.
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.
CONVERTIBLE SECURITIES. A convertible security is a bond, debenture, note,
preferred stock or other security that may be converted into or exchanged for a
prescribed amount of common stock of the same or a different issuer within a
particular period of time at a specified price or formula. A convertible
security entitles the holder to receive interest paid or accrued on debt or the
dividend paid on preferred stock until the convertible security matures or is
redeemed, converted or exchanged. Before conversion, convertible securities
have characteristics similar to nonconvertible debt securities in that they
ordinarily provide a stable stream of income with generally higher yields than
those of common stocks of the same or similar issuers. Convertible securities
rank senior to common stock in a corporation's capital structure but are
usually subordinated to comparable nonconvertible securities. While no
securities investment is without some risk, investments in convertible
securities generally entail less risk than the issuer's common stock, although
the extent
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to which such risk is reduced depends in large measure upon the degree to which
the convertible security sells above its value as a fixed income security.
Convertible securities have unique investment characteristics in that they
generally (1) have higher yields than common stocks, but lower yields than
comparable nonconvertible securities, (2) are less subject to fluctuation in
value than the underlying stock since they have fixed income characteristics
and (3) provide the potential for capital appreciation if the market price of
the underlying common stock increases.
The value of a convertible security is a function of its "investment value"
(determined by its yield comparison with the yields of other securities of
comparable maturity and quality that do not have a conversion privilege) and
its "conversion value" (the security's worth, at market value, if converted
into the underlying common stock). The investment value of a convertible
security is influenced by changes in interest rates, with investment value
declining as interest rates increase and increasing as interest rates decline.
The credit standing of the issuer and other factors also may have an effect on
the convertible security's investment value. The conversion value of a
convertible security is determined by the market price of the underlying common
stock. If the conversion value is low relative to the investment value, the
price of the convertible security is governed principally by its investment
value and generally the conversion value decreases as the convertible security
approaches maturity. To the extent the market price of the underlying common
stock approaches or exceeds the conversion price, the price of the convertible
security will be increasingly influenced by its conversion value. In addition,
a convertible security generally will sell at a premium over its conversion
value determined by the extent to which investors place value on the right to
acquire the underlying common stock while holding a fixed income security.
Investment Grade Income Fund has no current intention of converting any
convertible securities it may own into equity or holding them as equity upon
conversion, although it may do so for temporary purposes. A convertible
security may be subject to redemption at the option of the issuer at a price
established in the convertible security's governing instrument. If a
convertible security held by the Fund is called for redemption, the Fund will
be required to permit the issuer to redeem the security, convert it into the
underlying common stock or sell it to a third party.
ILLIQUID SECURITIES. Each Fund may invest up to 10% of its net assets (15%
for Low Duration Income Fund) in illiquid securities. The term "illiquid
securities" for this purpose means securities that cannot be disposed of within
seven days in the ordinary course of business at approximately the amount at
which a Fund has valued the securities and includes, among other things,
purchased over-the-counter ("OTC") options, repurchase agreements maturing in
more than seven days and restricted securities other than those Mitchell
Hutchins or PIMCO has determined are liquid pursuant to guidelines established
by the Trust's board of trustees. The assets used as cover for OTC options
written by a 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,
a 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
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may be permitted to sell a security under an effective registration statement.
If, during such a period, adverse market conditions were to develop, the Fund
might obtain a less favorable price than prevailed when it decided to sell.
Not all restricted securities are illiquid. In recent years a large
institutional market has developed for certain securities that are not
registered under the 1933 Act, including private placements, repurchase
agreements, commercial paper, foreign securities and corporate bonds and notes.
These instruments are often restricted securities because the securities are
sold in transactions not requiring registration. Institutional investors
generally will not seek to sell these instruments to the general public, but
instead will often depend either on an efficient institutional market in which
such unregistered securities can be readily resold or on an issuer's ability to
honor a demand for repayment. Therefore, the fact that there are contractual or
legal restrictions on resale to the general public or certain institutions is
not dispositive of the liquidity of such investments.
Rule 144A under the 1933 Act establishes a "safe harbor" from the
registration requirements of the 1933 Act for resales of certain securities to
qualified institutional buyers. Institutional markets for restricted securities
have developed as a result of Rule 144A, providing both readily ascertainable
values for restricted securities and the ability to liquidate an investment to
satisfy share redemption orders. Such markets include automated systems for the
trading, clearance and settlement of unregistered securities of domestic and
foreign issuers, such as the PORTAL System sponsored by the National
Association of Securities Dealers, Inc. An insufficient number of qualified
institutional buyers interested in purchasing Rule 144A-eligible restricted
securities held by a Fund, however, could affect adversely the marketability of
such portfolio securities, and a Fund might be unable to dispose of such
securities promptly or at favorable prices.
The Trust's board of trustees has delegated the function of making day-to-day
determinations of liquidity to Mitchell Hutchins or PIMCO, pursuant to
guidelines approved by the board. Mitchell Hutchins and PIMCO take 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). Mitchell Hutchins or PIMCO monitors the liquidity of restricted
securities in each Fund's portfolio and reports periodically on such decisions
to the board of trustees.
REPURCHASE AGREEMENTS. Repurchase agreements are transactions in which a 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. A 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 a
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Fund upon their acquisition is accrued as interest and included in the Fund's
net investment income.
Repurchase agreements carry certain risks not associated with direct
investments in securities, including possible declines in the market value of
the underlying securities and delays and costs to a Fund if the other party to
a repurchase agreement becomes insolvent. Each Fund intends to enter into
repurchase agreements only with banks and dealers in transactions believed by
Mitchell Hutchins or PIMCO to present minimum credit risks in accordance with
guidelines established by the Trust's board of trustees. Mitchell Hutchins or
PIMCO reviews and monitors the creditworthiness of those institutions under the
board's general supervision.
REVERSE REPURCHASE AGREEMENTS. As stated in the Prospectus, each Fund each
may enter into reverse repurchase agreements with banks and securities dealers.
Such agreements involve the sale of securities held by the Fund subject to the
Fund's agreement to repurchase the securities at an agreed-upon date and price
reflecting a market rate of interest. Such agreements are considered to be
borrowings and may be entered into only for temporary or emergency purposes.
While a reverse repurchase agreement is outstanding, a Fund's custodian
segregates assets to cover the amount of the Fund's obligations under the
reverse repurchase agreement. See "Investment Policies and Restrictions--
Segregated Accounts."
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. As stated in the Prospectus,
each 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 a
Fund's net asset value. When a 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 Funds purchase when-issued securities only with the intention of taking
delivery, but may sell the right to acquire the security prior to delivery if
Mitchell Hutchins or PIMCO deems it advantageous to do so, which may result in
capital gain or loss to a Fund.
FOREIGN SECURITIES. Investment Grade Income Fund may invest up to 20% of its
net assets in U.S. dollar-denominated securities of foreign issuers or foreign
branches of U.S. banks that are traded in the U.S. securities markets, or in
U.S. dollar-denominated securities the value of which is linked to the value of
foreign currencies. High Income Fund may invest up to 35% of its net assets in
securities of foreign issuers, with no more than 10% of its net assets in
securities of foreign issuers that are denominated and traded in currencies
other than the U.S. dollar. An investment in these Funds may involve risks
relating to political, social and economic developments abroad as well as risks
resulting from the differences between the regulations to which U.S. and
foreign issuers and markets are subject. These risks include expropriation,
confiscatory taxation, withholding taxes, political or social instability or
diplomatic developments. Moreover, individual foreign economies may differ
favorably or unfavorably from the U.S. economy in such respects as growth of
gross national product, rate of inflation, capital reinvestment, resource self-
sufficiency and balance of payments positions. To the extent these Funds invest
in foreign securities, the securities may not be registered with the Securities
and Exchange Commission ("SEC"), nor the issuers thereof subject to its
reporting requirements. Accordingly, there may be less publicly available
information
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concerning foreign issuers of securities held by these Funds than is available
concerning U.S. companies. Foreign companies are not generally subject to
uniform accounting, auditing and financial reporting standards or to other
regulatory requirements comparable to those applicable to U.S. companies.
Securities of many foreign companies may be less liquid and their prices more
volatile than those of securities of comparable U.S. companies. Transactions in
foreign securities may be subject to less efficient settlement practices. Legal
remedies for defaults and disputes may have to be pursued in foreign courts,
whose procedures differ substantially from those of U.S. courts. Foreign
securities trading practices, including those involving securities settlement
where High Income Fund assets may be released prior to receipt of payment, may
expose that Fund to increased risk in the event of a failed trade or the
insolvency of a foreign broker-dealer.
If the value of a foreign currency rises against the value of the U.S.
dollar, the value of Fund assets denominated in that currency or linked to that
currency will increase; correspondingly, if the value of a foreign currency
declines against the value of the U.S. dollar, the value of Fund assets
denominated in that currency or linked to that currency will decrease. The
exchange rates between the U.S. dollar and other currencies are determined by
supply and demand in the currency exchange markets, international balances of
payments, governmental intervention, speculation and other economic and
political conditions.
The costs attributable to foreign investing borne by High Income Fund
frequently are higher than those attributable to domestic investing. For
example, the cost of maintaining custody of foreign securities exceeds
custodian costs for domestic securities, and transaction and settlement costs
of foreign investing also frequently are higher than those attributable to
domestic investing. Costs associated with the exchange of currencies also make
foreign investing more expensive than domestic investing. Investment income on
certain foreign securities in which the Fund may invest may be subject to
foreign withholding or other government taxes that could reduce the return of
these securities. Tax treaties between the United States and foreign countries,
however, may reduce or eliminate the amount of foreign tax to which the Fund
would be subject.
LENDING OF PORTFOLIO SECURITIES. As indicated in the Prospectus, each Fund is
authorized to lend up to 33 1/3% of the total value of its portfolio securities
to broker-dealers or institutional investors that Mitchell Hutchins deems
qualified, but only when the borrower maintains acceptable collateral with the
Fund's custodian, marked to market daily, in an amount at least equal to the
market value of the securities loaned, plus accrued interest and dividends.
Acceptable collateral is limited to cash, U.S. government securities and
irrevocable letters of credit that meet certain guidelines established by
Mitchell Hutchins. In determining whether to lend securities to a particular
broker-dealer or institutional investor, Mitchell Hutchins will consider, and
during the period of the loan will monitor, all relevant facts and
circumstances, including the creditworthiness of the borrower. Each Fund will
retain authority to terminate any loan at any time. A 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. A 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. A 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.
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LOAN PARTICIPATIONS AND ASSIGNMENTS. Investment Grade Income Fund and High
Income Fund each may invest up to 5% of its net assets in secured or unsecured
fixed or floating rate loans ("Loans") arranged through private negotiations
between a borrowing corporation and one or more financial institutions
("Lenders"). The Funds' investments in Loans are expected in most instances to
be in the form of participations ("Participations") in Loans and assignments
("Assignments") of all or a portion of Loans from third parties. Participations
typically result in a Fund's having a contractual relationship only with the
Lender, not with the borrower. A Fund has the right to receive payments of
principal, interest and any fees to which it is entitled only from the Lender
selling the Participation and only upon receipt by the Lender of the payments
from the borrower. In connection with purchasing Participations, a Fund
generally has no direct right to enforce compliance by the borrower with the
terms of the loan agreement relating to the Loan, nor any rights of set-off
against the borrower, and the Fund may not directly benefit from any collateral
supporting the Loan in which it has purchased the Participation. As a result, a
Fund assumes the credit risk of both the borrower and the Lender that is
selling the Participation. In the event of the insolvency of the Lender selling
a Participation, a Fund may be treated as a general creditor of the Lender and
may not benefit from any set-off between the Lender and the borrower. The Funds
will acquire Participations only if the Lender interpositioned between the Fund
and the borrower is determined by Mitchell Hutchins to be creditworthy.
When a Fund purchases Assignments from Lenders, it acquires direct rights
against the borrower on the Loan. However, because Assignments are arranged
through private negotiations between potential assignees and assignors, the
rights and obligations acquired by a Fund as the purchaser of an Assignment may
differ from, and be more limited than, those held by the assigning Lender.
Assignments and Participations are generally not registered under the 1933
Act and thus are subject to each Fund's limitation on investment in illiquid
securities. Because there is no liquid market for such securities, the Funds
anticipate that such securities could be sold only to a limited number of
institutional investors. The lack of a liquid secondary market will have an
adverse impact on the value of such securities and on a Fund's ability to
dispose of particular Assignments or Participations when necessary to meet the
Fund's liquidity needs or in response to a specific economic event, such as a
deterioration in the creditworthiness of the borrower.
SEGREGATED ACCOUNTS. When a 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, interest rate protection transactions or forward
currency contracts.
INVESTMENT LIMITATIONS. Each Fund will not:
(1) purchase securities of any one issuer if, as a result, more than 5% of
the Fund's total assets would be invested in securities of that issuer
or the Fund would own or hold more than
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10% of the outstanding voting securities of that issuer, except that up to
25% of the Fund's total assets may be invested without regard to this
limitation, and except that this limitation does not apply to securities
issued or guaranteed by the U.S. government, its agencies and
instrumentalities or to securities issued by other investment companies.
The following interpretation applies to, but is not a part of, this
fundamental restriction: Mortgage- and asset-backed securities will not be
considered to have been issued by the same issuer by reason of the
securities having the same sponsor, and mortgage- and asset-backed
securities issued by a finance or other special purpose subsidiary that
are not guaranteed by the parent company will be considered to be issued
by a separate issuer from the parent company.
(2) purchase any security if, as a result of that purchase, 25% or more of
the Fund's total assets would be invested in securities of issuers
having their principal business activities in the same industry, except
that this limitation does not apply to securities issued or guaranteed
by the U.S. government, its agencies or instrumentalities or to
municipal securities, and except that U.S. Government Income Fund and
Low Duration Income Fund, under normal circumstances, each will invest
25% or more of its total assets 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.
(3) issue senior securities or borrow money, except as permitted under the
Investment Company Act of 1940 ("1940 Act") and then not in excess of
33 1/3% of the Fund's total assets (including the amount of the senior
securities issued but reduced by any liabilities not constituting
senior securities) at the time of the issuance or borrowing, except
that the Fund may borrow up to an additional 5% of its total assets
(not including the amount borrowed) for temporary or emergency
purposes.
(4) make loans, except through loans of portfolio securities or through
repurchase agreements, provided that for purposes of this restriction,
the acquisition of bonds, debentures, other debt securities or
instruments, or participations or other interests therein and
investments in government obligations, commercial paper, certificates
of deposit, banker's acceptances or similar instruments will not be
considered the making of a loan.
(5) engage in the business of underwriting securities of other issuers,
except to the extent that the Fund might be considered an underwriter
under the federal securities laws in connection with its disposition of
portfolio securities.
(6) purchase or sell real estate, except that investments in securities of
issuers that invest in real estate and investments in mortgage-backed
securities, mortgage participations or other instruments supported by
interests in real estate are not subject to this limitation, and except
that the Fund may exercise rights under agreements relating to such
securities, including the right to enforce security interests and to
hold real estate acquired by reason of such enforcement until that real
estate can be liquidated in an orderly manner.
(7) purchase or sell physical commodities unless acquired as a result of
owning securities or other instruments, but the Fund may purchase, sell
or enter into financial options and futures, forward and spot currency
contracts, swap transactions and other financial contracts or
derivative instruments.
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The foregoing fundamental investment limitations cannot be changed for any
Fund without the affirmative vote of the lesser of (1) more than 50% of the
outstanding shares of the Fund or (2) 67% or more of the shares of the Fund
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, later
changes in percentage resulting from a change in values of portfolio securities
or the amount of total assets will not be considered a violation of any of the
Funds' investment limitations, restrictions or investment policies.
The following investment restrictions, which apply to each Fund, are not
fundamental and may be changed by the Trust's board of trustees without
shareholder approval.
Each Fund will not:
(1) purchase or retain the securities of any issuer if the officers and
trustees of the Trust and the officers and directors of Mitchell
Hutchins (and, for Low Duration Income Fund, 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 (for Low Duration Income Fund, any security other
than mortgage- and asset-backed securities) if as a result more than 5%
of the value of the Fund's assets would be invested in securities of
companies that, together with any predecessors, have been in continuous
operation for less then three years.
(3) invest more than 10% (for Low Duration Income Fund, 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.
(4) make investments in warrants if such investments, valued at the lower
of cost or market, exceed 5% of the value of its net assets, which
amount may include warrants that are not listed on the New York Stock
Exchange, Inc. ("NYSE") or the American Stock Exchange, Inc., provided
that such 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.
(5) invest in real estate limited partnerships.
(6) change its investment policies to permit the Fund to invest more than
35% of its total assets in debt securities rated Ba or lower by Moody's
or BB or lower by S&P, comparably rated by another NRSRO or determined
by Mitchell Hutchins or PIMCO to be of comparable quality, without
giving at least 30 days' advance notice to shareholders, expect that
this restriction does not apply to High Income Fund.
(7) purchase securities on margin, except for short-term credit necessary
for clearance of portfolio transactions and except that the Fund may
make margin deposits in connection with its use of financial options
and futures, forward and spot currency contracts, swap transactions and
other financial contracts or derivative instruments.
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(8) engage in short sales of securities or maintain a short position, except
that the Fund may (a) sell short "against the box" and (b) maintain short
positions in connection with its use of financial options and futures,
forward and spot currency contracts, swap transactions and other
financial contracts or derivative instruments.
(9) invest in oil, gas or mineral exploration or development programs or
leases, except that investments in securities of issuers that invest in
such programs or leases and investments in asset-backed securities
supported by receivables generated from such programs or leases are not
subject to this prohibition.
(10) purchase securities of other investment companies, except to the
extent permitted by the 1940 Act and except that this limitation does
not apply to securities received or acquired as dividends, through
offers of exchange, or as a result of reorganization, consolidation,
or merger.
HEDGING AND RELATED INCOME STRATEGIES
GENERAL DESCRIPTION OF HEDGING STRATEGIES. As discussed in the Prospectus,
Mitchell Hutchins or 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 a Fund's
portfolio and to enhance income. Mitchell Hutchins or PIMCO also may attempt to
hedge a Fund's portfolio through the use of interest rate protection
transactions, and High Income Fund may use forward currency contracts for
hedging purposes. The particular Hedging Instruments used by the Funds are
described in Appendix C 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 a Fund's portfolio. Thus, in a short hedge a 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, a
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 a Fund intends to acquire. Thus, in a long
hedge a 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, a 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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Each 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. A Fund might enter into a long straddle when Mitchell Hutchins or
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. A
Fund might enter into a short straddle when Mitchell Hutchins or PIMCO 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 a 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
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, a Fund's ability to use Hedging Instruments will be
limited by tax considerations. See "Taxes."
In addition to the products, strategies and risks described below and in the
Prospectus, Mitchell Hutchins and PIMCO expect to discover additional
opportunities in connection with options, futures contracts and other hedging
techniques. These new opportunities may become available as Mitchell Hutchins
and PIMCO develop new techniques, as regulatory authorities broaden the range
of permitted transactions and as new options, futures contracts or other
techniques are developed. Mitchell Hutchins or PIMCO may utilize these
opportunities to the extent that they are consistent with the Funds' investment
objectives and permitted by the Funds' investment limitations and applicable
regulatory authorities. The Funds' Prospectus or Statement of Additional
Information will be supplemented to the extent that new products or techniques
involve materially different risks than those described below or in the
Prospectus.
SPECIAL RISKS OF HEDGING STRATEGIES. The use of Hedging Instruments involves
special considerations and risks, as described below. Risks pertaining to
particular Hedging Instruments are described in the sections that follow:
(1) Successful use of most Hedging Instruments depends upon Mitchell
Hutchins' or 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 Mitchell Hutchins and PIMCO are
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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(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 a Fund entered into a
short hedge because Mitchell Hutchins or 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, a 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 a 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 a 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 a Fund sell a portfolio
security at a disadvantageous time. A 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 a Fund to an obligation to another party. A Fund
will not enter into any such transactions unless it owns either (1) an
offsetting ("covered") position in securities, currencies (for High Income
Fund) or other options, futures contracts or (for High Income Fund) forward
currency 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. Each 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
a 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 Funds may purchase put and call options, and write (sell)
covered put and call options, on debt securities and (for High Income Fund)
foreign currencies. 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 a Fund to enhance income by reason of the premiums paid
by the purchasers of such options. In addition, 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
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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 of the option, minus the premium received, the Fund would expect to
suffer a loss. Writing covered call options serves as a limited short hedge,
because declines in the value of the hedged investment would be offset to the
extent of the premium received for writing the option. However, if the security
or currency appreciates to a price higher than the exercise price of the call
option, it can be expected that the option will be exercised and the Fund will
be obligated to sell the security or currency at less than its market value.
The securities or other assets used as cover for OTC options written by a 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.
A Fund may effectively terminate its right or obligation under an option by
entering into a closing transaction. For example, a 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, a 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 a Fund to realize profits
or limit losses on an option position prior to its exercise or expiration.
The Funds may purchase or write both exchange-traded and OTC options.
Exchange markets for options on debt securities and foreign currencies exist
but are relatively new, and these instruments are primarily traded on the OTC
market. Exchange-traded options in the United States are issued by a clearing
organization affiliated with the exchange on which the option is listed which,
in effect, guarantees completion of every exchange-traded option transaction.
In contrast, OTC options are contracts between the Fund and its contra party
(usually a securities dealer or a bank) with no clearing organization
guarantee. Thus, when the Fund purchases or writes an OTC option, 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. A Fund will enter into OTC option transactions only
with contra parties that have a net worth of at least $20 million.
A Fund's ability to establish and close out positions in exchange-listed
options depends on the existence of a liquid market. Each Fund intends to
purchase or write only those exchange-traded options for which there appears to
be a liquid secondary market. However, there can be no assurance that such a
market will exist at any particular time. Closing transactions can be made for
OTC options only by negotiating directly with the contra party, or by a
transaction in the secondary market if any such market exists. Although a Fund
will enter into OTC options only with contra
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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 a 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 a 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.
A Fund may purchase and write put and call options on indices of debt
securities in much the same manner as the more traditional options discussed
above, except the index options may serve as a hedge against overall
fluctuations in the debt securities market (or market sectors) rather than
anticipated increases or decreases in the value of a particular security.
GUIDELINES FOR OPTIONS. Each 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. A 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 purchased by the Fund, does not exceed 5% of the Fund's total
assets.
2. The aggregate value of securities underlying put options written by any
Fund determined as of the date the put options are written, will not exceed 50%
of the Fund's net assets.
3. The aggregate premiums paid on all options (including options on
securities, foreign currencies and indices of debt securities and options on
futures contracts) purchased by the Fund that are held at any time will not
exceed 20% of the Fund's net assets.
FUTURES. The Funds may purchase and sell interest rate futures contracts and
Low Duration Fund may purchase and sell debt securities index futures
contracts. Each Fund also may purchase put and call options, and write covered
put and call options, on the futures contracts it is allowed to purchase and
sell. 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 options on securities or indices.
Futures strategies also can be used to manage the average duration of a
Fund's portfolio. If Mitchell Hutchins or PIMCO wishes to shorten the average
duration of a Fund, the Fund may sell an interest rate futures contract or a
call option thereon, or purchase a put option on that futures contract. If
Mitchell Hutchins or PIMCO wishes to lengthen the average duration of a Fund,
the Fund may buy an interest rate futures contract or a call option thereon or
sell a put option thereon.
Each 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
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contract position. Such options would have the same strike prices and
expiration dates. A Fund will engage in this strategy only when it is more
advantageous to the Fund than is purchasing the futures contract.
No price is paid upon entering into a futures contract. Instead, at the
inception of a futures contract a 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 a Fund's obligations to or from a futures
broker. When a Fund purchases an option on a future, the premium paid plus
transaction costs is all that is at risk. In contrast, when a 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.
Each 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 a Fund were unable to liquidate a futures or 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.
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Certain characteristics of the futures market might increase the risk that
movements in the prices of futures contracts or related options might not
correlate perfectly with movements in the prices of the investments being
hedged. For example, all participants in the futures and related options
markets are subject to daily variation margin calls and might be compelled to
liquidate futures or related options positions whose prices are moving
unfavorably to avoid being subject to further calls. These liquidations could
increase price volatility of the instruments and distort the normal price
relationship between the futures or options and the investments being hedged.
Also, because initial margin deposit requirements in the futures market are
less onerous than margin requirements in the securities markets, there might be
increased participation by speculators in the futures markets. This
participation also might cause temporary price distortions. In addition,
activities of large traders in both the futures and securities markets
involving arbitrage, "program trading" and other investment strategies might
result in temporary price distortions.
GUIDELINES FOR FUTURES AND RELATED OPTIONS. Each 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 a Fund enters into futures contracts and options on futures
positions including, for High Income Fund, options on foreign currencies traded
on a commodities exchange that are not for bona fide hedging purposes (as
defined by the CFTC), the aggregate initial margin and premiums on those
positions (excluding the amount by which options are "in-the-money") may not
exceed 5% of the Fund's net assets.
2. The aggregate premiums paid on all options (including options on
securities, foreign currencies and indices of debt securities and options on
futures contracts) purchased by a Fund that are held at any time will not
exceed 20% of the Fund's net assets.
3. The aggregate margin deposits on all futures contracts and options thereon
held at any time by the Fund will not exceed 5% of the Fund's total assets.
FOREIGN CURRENCY HEDGING STRATEGIES--SPECIAL CONSIDERATIONS. High Income Fund
may use options on foreign currencies, as described above, and forward currency
contracts, as described below, to hedge against movements in the values of the
foreign currencies in which that Fund's securities are denominated. Such
currency hedges can protect against price movements in a security High Income
Fund owns or intends to acquire that are attributable to changes in the value
of the currency in which it is denominated. Such hedges do not, however,
protect against price movements in the securities that are attributable to
other causes.
High Income Fund might seek to hedge against changes in the value of a
particular currency when no Hedging Instruments on that currency are available
or such Hedging Instruments are more expensive than certain other Hedging
Instruments. In such cases, High Income Fund may hedge against price movements
in that currency by entering into transactions using Hedging Instruments on
another currency or a basket of currencies, the value of which Mitchell
Hutchins believes will have a positive correlation to the value of the currency
being hedged. The risk that movements in the price of the Hedging Instrument
will not correlate perfectly with movements in the price of the currency being
hedged is magnified when this strategy is used.
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The value of Hedging Instruments on foreign currencies depends on the value
of the underlying currency relative to the U.S. dollar. Because foreign
currency transactions occurring in the interbank market might involve
substantially larger amounts than those involved in the use of such Hedging
Instruments, High Income Fund could be disadvantaged by having to deal in the
odd lot market (generally consisting of transactions of less than $1 million)
for the underlying foreign currencies at prices that are less favorable than
for round lots.
There is no systematic reporting of last sale information for foreign
currencies or any regulatory requirement that quotations available through
dealers or other market sources be firm or revised on a timely basis. Quotation
information generally is representative of very large transactions in the
interbank market and thus might not reflect odd-lot transactions where rates
might be less favorable. The interbank market in foreign currencies is a
global, round-the-clock market. To the extent the U.S. options or futures
markets are closed while the markets for the underlying currencies remain open,
significant price and rate movements might take place in the underlying markets
that cannot be reflected in the markets for the Hedging Instruments until they
reopen.
Settlement of hedging transactions involving foreign currencies might be
required to take place within the country issuing the underlying currency.
Thus, High Income Fund might be required to accept or make delivery of the
underlying foreign currency in accordance with any U.S. or foreign regulations
regarding the maintenance of foreign banking arrangements by U.S. residents and
might be required to pay any fees, taxes and charges associated with such
delivery assessed in the issuing country.
FORWARD CURRENCY CONTRACTS. High Income Fund may enter into forward currency
contracts to purchase or sell foreign currencies for a fixed amount of U.S.
dollars or another foreign currency. Such transactions may serve as long
hedges--for example, High Income Fund may purchase a forward currency contract
to lock in the U.S. dollar price of a security denominated in a foreign
currency that the Fund intends to acquire. Forward currency transactions may
also serve as short hedges--for example, High Income Fund may sell a forward
currency contract to lock in the U.S. dollar equivalent of the proceeds from
the anticipated sale of a security denominated in a foreign currency.
As noted above, High Income Fund also may seek to hedge against changes in
the value of a particular currency by using forward contracts on another
foreign currency or a basket of currencies, the value of which Mitchell
Hutchins believes will have a positive correlation to the value of the currency
being hedged. In addition, the Fund may use forward currency contracts to shift
its exposure to foreign currency fluctuations from one country to another. For
example, if the Fund owned securities denominated in a foreign currency and
Mitchell Hutchins believed that currency would decline relative to another
currency, it might enter into a forward contract to sell an appropriate amount
of the first foreign currency, with payment to be made in the second foreign
currency. Transactions that use two foreign currencies are sometimes referred
to as "cross hedging." Use of a different foreign currency magnifies the risk
that movements in the price of the Hedging Instrument will not correlate or
will correlate unfavorably with the foreign currency being hedged.
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The cost to High Income Fund of engaging in forward currency contracts varies
with factors such as the currency involved, the length of the contract period
and the market conditions then prevailing. Because forward currency contracts
are usually entered into on a principal basis, no fees or commissions are
involved. When the Fund enters into a forward currency contract, it relies on
the contra party to make or take delivery of the underlying currency at the
maturity of the contract. Failure by the contra party to do so would result in
the loss of any expected benefit of the transaction.
As is the case with futures contracts, holders and writers of forward
currency contracts can enter into offsetting closing transactions, similar to
closing transactions on futures, by selling or purchasing, respectively, an
instrument identical to the instrument purchased or sold. Secondary markets
generally do not exist for forward currency contracts, with the result that
closing transactions generally can be made for forward currency contracts only
by negotiating directly with the contra party. Thus, there can be no assurance
that the Fund will in fact be able to close out a forward currency contract at
a favorable price prior to maturity. In addition, in the event of insolvency of
the contra party, the Fund might be unable to close out a forward currency
contract at any time prior to maturity. In either event, the Fund would
continue to be subject to market risk with respect to the position, and would
continue to be required to maintain a position in the securities or currencies
that are the subject of the hedge or to maintain cash or securities in a
segregated account.
The precise matching of forward currency contract amounts and the value of
the securities involved generally will not be possible because the value of
such securities, measured in the foreign currency, will change after the
forward currency contract has been established. Thus, High Income Fund might
need to purchase or sell foreign currencies in the spot (cash) market to the
extent such foreign currencies are not covered by forward contracts. The
projection of short-term currency market movements is extremely difficult, and
the successful execution of a short-term hedging strategy is highly uncertain.
LIMITATIONS ON THE USE OF FORWARD CURRENCY CONTRACTS. High Income Fund may
enter into forward currency contracts or maintain a net exposure to such
contracts only if (1) the consummation of the contracts would not obligate the
Fund to deliver an amount of foreign currency in excess of the value of the
position being hedged by such contracts or (2) the Fund maintains appropriate
assets in a segregated account in an amount not less than the value of its
total assets committed to the consummation of the contract and not covered as
provided in (1) above, as marked to market daily.
INTEREST RATE PROTECTION TRANSACTIONS
The Funds 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
20
<PAGE>
the case of a floor) a designated level on predetermined dates or during a
specified time period. Interest rate collar transactions involve an agreement
between two parties in which payments are made when a designated market
interest rate either goes above a designated ceiling level or goes below a
designated floor on predetermined dates or during a specified time period. The
Funds intend 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.
Each Fund may enter into interest rate swaps, caps, collars and floors on
either an asset-based or liability-based basis, depending on whether it is
hedging its assets or its liabilities, and will usually enter into interest
rate swaps on a net basis, i.e., the two payment streams are netted out, with
the Fund receiving or paying, as the case may be, only the net amount of the
two payments. Inasmuch as these interest rate protection transactions are
entered into for good faith hedging purposes, and inasmuch as segregated
accounts will be established with respect to such transactions, Mitchell
Hutchins, PIMCO and the Funds 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 a 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." Each 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 Funds will enter into interest rate protection transactions only with
banks and recognized securities dealers believed by Mitchell Hutchins or 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, a Fund will have to rely on its contractual remedies (which may
be limited by bankruptcy, insolvency or similar laws) pursuant to the
agreements related to the transaction.
The swap market has grown substantially in recent years with a large number
of banks and investment banking firms acting both as principals and as agents
utilizing standardized swap documentation. Caps, collars and floors are more
recent innovations for which documentation is less standardized, and
accordingly, they are less liquid than swaps.
21
<PAGE>
TRUSTEES AND OFFICERS; PRINCIPAL HOLDERS OF SECURITIES
The trustees and executive officers of the Trust, their ages, business
addresses and principal occupations during the past five years are:
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE POSITION WITH TRUST OTHER DIRECTORSHIPS
---------------------- ------------------- --------------------
<C> <C> <S>
Margo N. Alexander**; 49 Trustee and President Mrs. Alexander is presi-
dent, chief executive
officer and a director
of Mitchell Hutchins
(since January 1995)
and also an executive
vice president and a
director of
PaineWebber. Mrs. Alex-
ander is president and
a director or trustee
of 30 investment compa-
nies for which Mitchell
Hutchins or PaineWebber
serves as investment
adviser.
Richard Q. Armstrong; 60 Trustee Mr. Armstrong is chair-
78 West Brother Drive man and principal of
Greenwich, CT 06830 RQA Enterprises (man-
agement consulting
firm) (since April 1991
and principal occupa-
tion since March 1995).
Mr. Armstrong is also a
director of Hi Lo Auto-
motive, Inc. He was
chairman of the board,
chief executive officer
and co-owner of Adiron-
dack Beverages (pro-
ducer and distributor
of soft drinks and
sparkling/still waters)
(October 1993-March
1995). He was a partner
of the New England Con-
sulting Group (manage-
ment consulting firm)
(December 1992-Septem-
ber 1993). He was man-
aging director of LMVH
U.S. Corporation (U.S.
subsidiary of the
French luxury goods
conglomerate, Luis
Vuitton Moet Hennessey
Corporation) (1987-
1991) and chairman of
its wine and spirits
subsidiary, Schieffelin
& Somerset Company
(1987-1991). Mr. Arm-
strong is a
director or trustee of
29 investment companies
for which Mitchell
Hutchins or PaineWebber
serves as investment
adviser.
</TABLE>
22
<PAGE>
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE POSITION WITH TRUST OTHER DIRECTORSHIPS
---------------------- ------------------- --------------------
<C> <C> <S>
E. Garrett Bewkes, Jr.**; 69 Trustee and Mr. Bewkes is a director
Chairman of the of Paine Webber Group
Board of Trustees Inc. ("PW Group")
(holding company of
PaineWebber and Mitch-
ell Hutchins). Prior to
December 1995, he was a
consultant to PW Group.
Prior to 1988, he was
chairman of the board,
president and chief ex-
ecutive officer of
American Bakeries Com-
pany. Mr. Bewkes is
also a director of In-
terstate Bakeries Cor-
poration, NaPro
BioTherapeutics, Inc.
and a director or
trustee of 30 invest-
ment companies for
which Mitchell Hutchins
or PaineWebber serves
as investment adviser.
Richard R. Burt; 49 Trustee Mr. Burt is chairman of
1101 Connecticut Avenue, N.W. International Equity
Washington, D.C. 20036 Partners (international
investments and con-
sulting firm) (since
March 1994) and a part-
ner of McKinsey & Com-
pany (management con-
sulting firm) (since
1991). He is also a di-
rector of American Pub-
lishing Company. He was
the chief negotiator in
the Strategic Arms Re-
duction Talks with the
former Soviet Union
(1989-1991) and the
U.S. Ambassador to the
Federal Republic of
Germany (1985-1989).
Mr. Burt is a director
or trustee of 29 in-
vestment companies for
which Mitchell Hutchins
or PaineWebber serves
as investment adviser.
Mary C. Farrell**; 46 Trustee Ms. Farrell is a manag-
ing director, senior
investment strategist
and member of the In-
vestment Policy Commit-
tee of PaineWebber. Ms.
Farrell joined
PaineWebber in 1982.
She is a member of the
Financial Women's Asso-
ciation and Women's
Economic Roundtable and
is employed as a regu-
lar panelist on Wall
Street Week with Louis
Rukeyser. She also
serves on the Board of
Overseers of New York
University's Stern
School of Business. Ms.
Farrell is a director
or trustee of 29 in-
vestment companies for
which Mitchell Hutchins
or PaineWebber serves
as investment adviser.
</TABLE>
23
<PAGE>
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE POSITION WITH TRUST OTHER DIRECTORSHIPS
---------------------- ------------------- --------------------
<C> <C> <S>
Meyer Feldberg; 54 Trustee Mr. Feldberg is Dean and
Columbia University Professor of Management
101 Uris Hall of the Graduate School
New York, New York 10027 of Business, Columbia
University. Prior to
1989, he was president
of the Illinois Insti-
tute of Technology.
Dean Feldberg is also a
director of AMSCO In-
ternational Inc., Fed-
erated Department
Stores, Inc., and New
World Communications
Group Incorporated and
a director or trustee
of 29 investment compa-
nies for which Mitchell
Hutchins or PaineWebber
serves as investment
adviser.
George W. Gowen; 66 Trustee Mr. Gowen is a partner
666 Third Avenue in the law firm of Dun-
New York, New York 10017 nington, Bartholow &
Miller. Prior to May
1994, he was a partner
in the law firm of Fry-
er, Ross & Gowen. Mr.
Gowen is also a direc-
tor of Columbia Real
Estate Investments,
Inc. and a director or
trustee of 29 invest-
ment companies for
which Mitchell Hutchins
or PaineWebber serves
as investment adviser.
Frederic V. Malek; 59 Trustee Mr. Malek is chairman of
901 15th Street, N.W. Thayer Capital Partners
Suite 300 (investment bank) and a
Washington, D.C. 20005 co-chairman and direc-
tor of CB Commercial
Group Inc. (real es-
tate). 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 Hold-
ings Inc. (holding com-
pany of NWA Inc.).
Prior to 1989, he was
employed by the
Marriott Corporation
(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., Auto-
matic
</TABLE>
24
<PAGE>
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE POSITION WITH TRUST OTHER DIRECTORSHIPS
---------------------- ------------------- --------------------
<C> <C> <S>
Data Processing, Inc.,
Avis, Inc., FPL Group,
Inc., ICF Internation-
al, Manor Care, Inc.,
National Education Cor-
poration and Northwest
Airlines Inc. Mr. Malek
is a director or
trustee of 29 other in-
vestment companies for
which Mitchell Hutchins
or PaineWebber serves
as investment adviser.
Carl W. Schafer; 60 Trustee Mr. Schafer is president
P.O. Box 1164 of the Atlantic Founda-
Princeton, NJ 08542 tion, (charitable foun-
dation supporting
mainly oceanographic
exploration and re-
search). He also is a
director of Roadway Ex-
press, Inc. (trucking),
The Guardian Group of
Mutual Funds, Evans
Systems, Inc. (a motor
fuels, convenience
store and diversified
company), Hidden Lake
Gold Mines Ltd. (gold
mining), Electronic
Clearing House, Inc.
(financial transactions
processing), Wainoco
Oil Corporation and
Nutraceutix, Inc. (bio-
technology). Prior to
January 1993, he was
chairman of the Invest-
ment Advisory Committee
of the Howard Hughes
Medical Institute. Mr.
Schafer is a director
or trustee of 29 in-
vestment companies for
which Mitchell Hutchins
or PaineWebber serves
as investment adviser.
John R. Torell III; 56 Trustee Mr. Torell is chairman
767 Fifth Avenue of Torell Management,
Suite 4605 Inc. (financial advi-
New York, NY 10153 sory firm), chairman of
Telesphere Corporation
(electronic provider of
financial information)
and a partner of Zilkha
& Company (merchant
bank and private in-
vestment company). He
is the former chairman
and chief executive of-
ficer of Fortune
Bancorp (1990-1991 and
1990-1994, respective-
ly), the former chair-
man, president and
chief executive officer
of CalFed, Inc. (sav-
ings association) (1988
to 1989) and the former
president of Manufac-
turers Hanover Corp.
(bank) (prior to
</TABLE>
25
<PAGE>
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE POSITION WITH TRUST OTHER DIRECTORSHIPS
---------------------- ------------------- --------------------
<C> <C> <S>
1988). Mr. Torell is
also a director of
American Home Products
Corp., New Colt Inc.
(armament manufacturer)
and Volt Information
Sciences Inc. Mr.
Torell is a director or
trustee of 29 invest-
ment companies for
which Mitchell Hutchins
or PaineWebber serves
as investment adviser.
Julieanna Berry; 32 Vice President Ms. Berry is a vice
president and a portfo-
lio manager of Mitchell
Hutchins. Ms. Berry is
a vice president of two
investment companies
for which Mitchell
Hutchins or PaineWebber
serves as investment
adviser.
Teresa M. Boyle; 37 Vice President Ms. Boyle is a first
vice president and
manager--advisory ad-
ministration of Mitch-
ell Hutchins. Prior to
November 1993, she was
compliance manager of
Hyperion Capital Man-
agement, Inc., an in-
vestment advisory firm.
Prior to April 1993,
Ms. Boyle was a vice
president and manager--
legal administration of
Mitchell Hutchins. Ms.
Boyle is a vice presi-
dent of 30 investment
companies for which
Mitchell Hutchins or
PaineWebber serves as
investment adviser.
Karen L. Finkel; 38 Vice President Mrs. Finkel is a first
vice president and a
portfolio manager of
Mitchell Hutchins. Mrs.
Finkel is a vice presi-
dent of two investment
companies for which
Mitchell Hutchins
serves as investment
adviser.
Ellen R. Harris; 49 Vice President Ms. Harris is a managing
director and a portfo-
lio manager of Mitchell
Hutchins. Ms. Harris is
a vice president of
three investment compa-
nies for which Mitchell
Hutchins or PaineWebber
serves as investment
adviser.
James F. Keegan; 35 Vice President Mr. Keegan is a senior
vice president and a
portfolio manager of
Mitchell Hutchins.
Prior to March 1996, he
was
</TABLE>
26
<PAGE>
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE POSITION WITH TRUST OTHER DIRECTORSHIPS
---------------------- ------------------- --------------------
<C> <C> <S>
director of fixed in-
come strategy and re-
search of Merrion
Group, L.P. From 1987
to 1994, he was a vice
president of Bankers
Trust Company where he
was the director of
credit research for the
global investment man-
agement group. Mr.
Keegan is a vice presi-
dent of two investment
companies for which
Mitchell Hutchins or
PaineWebber serves as
investment adviser.
Thomas J. Libassi; 37 Vice President Mr. Libassi is a senior
vice president and a
portfolio manager of
Mitchell Hutchins.
Prior to May 1994, he
was a vice president of
Keystone Custodian
Funds Inc. with portfo-
lio management respon-
sibility. Mr. Libassi
is a vice president of
four investment compa-
nies for which Mitchell
Hutchins serves as in-
vestment adviser.
C. William Maher; 35 Vice President and Mr. Maher is a first
Assistant Treasurer vice president and a
senior manager of the
mutual fund finance di-
vision of Mitchell
Hutchins. Mr. Maher is
a vice president and
assistant treasurer of
30 investment companies
for which Mitchell
Hutchins or PaineWebber
serves as investment
adviser.
Dennis McCauley; 49 Vice President Mr. McCauley is a manag-
ing director and chief
investment officer--
fixed income of Mitch-
ell Hutchins. Prior to
December 1994, he was
Director of Fixed In-
come Investments of IBM
Corporation.
Mr. McCauley is a vice
president of 19 invest-
ment companies for
which Mitchell Hutchins
or PaineWebber serves
as investment adviser.
Ann E. Moran; 38 Vice President and Ms. Moran is a vice
Assistant Treasurer president of Mitchell
Hutchins. Ms. Moran is
a vice president and
assistant treasurer of
30 investment companies
for which Mitchell
Hutchins or PaineWebber
serves as investment
adviser.
</TABLE>
27
<PAGE>
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE POSITION WITH TRUST OTHER DIRECTORSHIPS
---------------------- ------------------- --------------------
<C> <C> <S>
Dianne E. O'Donnell; 43 Vice President Ms. O'Donnell is a se-
and Secretary nior vice president and
deputy general counsel
of Mitchell Hutchins.
Ms. O'Donnell is a vice
president and secretary
of 30 investment compa-
nies for which Mitchell
Hutchins or PaineWebber
serves as investment
adviser.
Victoria E. Schonfeld; 45 Vice President Ms. Schonfeld is a man-
aging director and gen-
eral counsel of Mitch-
ell Hutchins. Prior to
May 1994, she was a
partner in the law firm
of Arnold & Porter. Ms.
Schonfeld is a vice
president of 30 invest-
ment companies for
which Mitchell Hutchins
or PaineWebber serves
as investment adviser.
Paul H. Schubert; 33 Vice President Mr. Schubert is a first
and Assistant vice president and a
Treasurer senior manager of the
mutual fund finance di-
vision of Mitchell
Hutchins. From August
1992 to August 1994, he
was a vice president at
BlackRock Financial
Management L.P. Prior
to August 1992, he was
an audit manager with
Ernst & Young LLP. Mr.
Schubert is a vice
president and assistant
treasurer of 30 invest-
ment companies for
which Mitchell Hutchins
or PaineWebber serves
as investment adviser.
Nirmal Singh; 39 Vice President Mr. Singh is a first
vice president of
Mitchell Hutchins.
Prior to September
1993, he was a member
of the portfolio man-
agement team at Merrill
Lynch Asset Management,
Inc. Mr. Singh is a
vice president of five
investment companies
for which Mitchell
Hutchins or PaineWebber
serves as investment
adviser.
</TABLE>
28
<PAGE>
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE POSITION WITH TRUST OTHER DIRECTORSHIPS
---------------------- ------------------- --------------------
<C> <C> <S>
Julian F. Sluyters; 35 Vice President and Mr. Sluyters is a senior
Treasurer vice 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 a vice
president and treasurer
of 30 investment compa-
nies for which Mitchell
Hutchins or PaineWebber
serves as investment
adviser.
Mark A. Tincher; 40 Vice President Mr. Tincher is a manag-
ing director and chief
investment officer--
U.S. equity investments
of Mitchell Hutchins.
Prior to March 1995, he
was a vice president
and directed the U.S.
funds management and
equity research areas
of Chase Manhattan Pri-
vate Bank. Mr. Tincher
is a vice president of
14 investment companies
for which Mitchell
Hutchins or PaineWebber
serves as investment
adviser.
Craig M. Varrelman; 37 Vice President Mr. Varrelman is a first
vice president and a
portfolio manager of
Mitchell Hutchins. Mr.
Varrelman is a vice
president of five
investment companies
for which Mitchell
Hutchins or PaineWebber
serves as investment
adviser.
Keith A. Weller; 34 Vice President and Mr. Weller is a first
Assistant Secretary vice president and
associate general
counsel of Mitchell
Hutchins. Prior to May
1995, he was an
attorney in private
practice. Mr. Weller is
a vice president and
assistant secretary of
29 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.
** Mrs. Alexander, Mr. Bewkes and Ms. Farrell are "interested persons" of the
Trust as defined in the 1940 Act by virtue of their positions with Mitchell
Hutchins, PaineWebber and/or PW Group.
29
<PAGE>
The Trust pays trustees who are not "interested persons" of the Trust $1,000
annually for each series of the Trust and $150 for each board meeting and each
separate meeting of a board committee. The Trust presently has five series and
thus pays each such trustee $5,000 annually, plus any additional amounts due
for board or committee meetings. Certain committee chairs receive additional
compensation aggregating $15,000 annually from all the funds within the
PaineWebber fund complex. Trustees of the Trust who are "interested persons"
receive no compensation from the Trust. All trustees 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 each Fund. Because
PaineWebber and Mitchell Hutchins perform substantially all of the services
necessary for the operation of the Trust and the Funds, 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 current trustees who held office with the Trust or other
PaineWebber funds during the fiscal year ended November 30, 1995.
COMPENSATION TABLE
<TABLE>
<CAPTION>
TOTAL
AGGREGATE COMPENSATION
COMPENSATION FROM THE TRUST
FROM THE AND THE
NAME OF PERSON, POSITION TRUST* TRUST COMPLEX+
- ------------------------ ------------ --------------
<S> <C> <C>
Richard Q. Armstrong, Trustee ...................... -- $ 9,000
Richard Burt, Trustee............................... -- $ 7,750
Meyer Feldberg, Trustee............................. $7,250 $106,375
George W. Gowen, Trustee............................ $7,250 $ 99,750
Frederic V. Malek, Trustee.......................... $7,250 $ 99,750
Carl W. Schafer, Trustee............................ -- $118,175
John R. Torell, III, Trustee........................ -- $ 28,125
</TABLE>
- --------
Only independent members of the board of trustees are compensated by the Trust
and identified above; trustees who are "interested persons," as defined by the
1940 Act, do not receive compensation.
* Represents fees paid to each trustee during the fiscal year ended November
30, 1995; the Trust does not have a pension or retirement plan.
+ Represents total compensation paid to each trustee during the calendar year
ended December 31, 1995.
30
<PAGE>
BENEFICIAL OWNERSHIP OF GREATER THAN 5% OF FUND SHARES
The following shareholders are shown in the Trust's records as owning more
than 5% of Low Duration Income Fund's shares.
<TABLE>
<CAPTION>
NUMBER AND PERCENTAGE OF
SHARES BENEFICIALLY
OWNED
NAME AND ADDRESS* AS OF JANUARY 31, 1996
- ----------------- ------------------------
<S> <C>
Hilton Hotels Corporation.............................. 9,100,500.000 (7.2%)
Kern County Treasurer.................................. 8,585,131.170 (6.8%)
</TABLE>
- --------
* Each of the shareholders listed may be contacted c/o Mitchell Hutchins Asset
Management Inc., 1285 Avenue of the Americas, New York, NY 10019.
INVESTMENT ADVISORY AND DISTRIBUTION ARRANGEMENTS
INVESTMENT ADVISORY ARRANGEMENTS. Mitchell Hutchins acts as the investment
adviser and administrator of each Fund pursuant to a contract with the Trust
dated April 21, 1988, as supplemented by a separate fee agreement dated March
26, 1993 with respect to Low Duration Income Fund ("Advisory Contract"). Under
the Advisory Contract, the Trust pays Mitchell Hutchins an annual fee, computed
daily and paid monthly, at the rate of 0.50% of each Fund's average daily net
assets.
During the fiscal years ended November 30, 1995, November 30, 1994 and
November 30, 1993, respectively, the Trust paid (or accrued) to Mitchell
Hutchins investment advisory and administrative fees of $2,784,437, $3,958,127
and $4,999,240 with respect to the U.S. Government Income Fund, $1,890,394,
$1,897,899 and $1,393,289 with respect to the Investment Grade Income Fund and
$3,050,197, $4,047,201 and $3,100,195 with respect to the High Income Fund.
During the fiscal years ended November 30, 1995 and November 30, 1994 and the
period May 3, 1993 (commencement of operations) to November 30, 1993, the Trust
paid (or accrued) to Mitchell Hutchins investment advisory and administrative
fees of $1,839,876, $5,598,491 (of which $400,611 was waived by Mitchell
Hutchins) and $3,519,442 with respect to Low Duration Income Fund.
Under a service agreement pursuant to which PaineWebber provides certain
services to each Fund not otherwise provided by the Funds' transfer agent,
which agreement is reviewed by the Trust's board of trustees annually, during
the fiscal years ended November 30, 1995, November 30, 1994 and November 30,
1993, respectively, PaineWebber earned fees in the amounts of $154,428,
$196,490 and $217,612 for U.S. Government Income Fund, $99,641, $97,475 and
$60,450 for Investment Grade Income Fund and $158,323, $181,748 and $137,332
for High Income Fund. During the fiscal years ended November 30, 1995 and
November 30, 1994 and the period May 3, 1993 (commencement of operations) to
November 30, 1993, respectively, PaineWebber earned fees under the service
agreement in the amounts of $107,999, $139,291 and $71,854 for Low Duration
Income Fund.
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-
31
<PAGE>
adviser for Low Duration Income 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 fiscal
year ended November 30, 1995 and the period October 20, 1994 to November 30,
1994, Mitchell Hutchins paid (or accrued) to PIMCO sub-advisory fees of
$919,938 and $147,540, pursuant to the Sub-Advisory Contract and a
substantially similar prior contract.
Under the terms of the Advisory Contract, each Fund bears all expenses
incurred in its operation that are not specifically assumed by Mitchell
Hutchins. General expenses of the Trust not readily identifiable as belonging
to a particular series of the Trust are allocated among the series of the Trust
(including the Funds) 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 Funds include the following (or each 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 a 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 a 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 a 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 a Fund is 2.5% of the first $30 million of the Fund's
average daily net assets, 2.0% of the next $70 million of its average daily net
assets and 1.5% of its average daily net assets in excess of $100 million.
Certain expenses, such as brokerage commissions, taxes, interest, distribution
fees, certain expenses attributed to investing outside the United States and
extraordinary items, are excluded from this limitation. For the fiscal years
ended November 30, 1995, November 30, 1994 and November 30, 1993, no
reimbursements were required pursuant to such limitations.
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
any Fund in connection with the performance
32
<PAGE>
of the Contract, except a loss resulting from willful misfeasance, bad faith or
gross negligence on the part of Mitchell Hutchins in the performance of its
duties or from reckless disregard of its duties and obligations thereunder.
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, Low Duration
Income Fund, its shareholders or Mitchell Hutchins in connection with the Sub-
Advisory Contract, except any liability to any of them 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 with respect to each Fund 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 Trust. 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 Low Duration Income 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 29, 1996,
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)
------------------- ----------
<C> <S> <C>
Domestic (excluding
Money Market)......... $5,653.6
Global................. 2,836.8
Equity/Balanced........ 2,922.3
Fixed Income (excluding
Money Market)......... 5,568.1
Taxable Fixed In-
come............... 3,854.2
Tax-Free Fixed In-
come............... 1,713.9
Money Market Funds..... 22,732.0
</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 other PaineWebber funds and other Mitchell Hutchins' advisory
accounts by all Mitchell Hutchins' directors, officers and employees,
establishes procedures for personal investing and restricts certain
transactions. For example, employee accounts generally must be maintained at
PaineWebber, personal trades in most securities require pre-clearance and
short-term trading and participation in initial public offerings generally are
prohibited. In addition, the code of ethics puts restrictions on the timing of
personal investing in relation to trades by PaineWebber funds and other
Mitchell Hutchins advisory clients.
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.
33
<PAGE>
DISTRIBUTION ARRANGEMENTS. Mitchell Hutchins acts as the distributor of the
Class A, Class B and Class C shares of each Fund under separate distribution
contracts with the Trust dated July 7, 1993 or November 10, 1995 (collectively,
"Distribution Contracts") that require Mitchell Hutchins to use its best
efforts, consistent with its other businesses, to sell shares of the Funds.
Shares of the Funds are offered continuously. Under separate exclusive dealer
agreements between Mitchell Hutchins and PaineWebber dated July 7, 1993 or
November 10, 1995, relating to the Class A, Class B and Class C shares of each
Fund (collectively, "Exclusive Dealer Agreements"), PaineWebber and its
correspondent firms sell each Fund's shares.
Under separate plans of distribution pertaining to the Class A, Class B and
Class C shares of the Funds adopted by the Trust in the manner prescribed under
Rule 12b-1 under the 1940 Act ("Class A Plan," "Class B Plan" and "Class C
Plan," collectively, "Plans"), each Fund pays Mitchell Hutchins a service fee,
accrued daily and payable monthly, at the annual rate of 0.25% of the average
daily net assets of each Class of shares. Under the Class B Plan, each Fund
also pays Mitchell Hutchins a distribution fee, accrued daily and payable
monthly, at the annual rate of 0.75% of the average daily net assets of the
Class B shares. Under the Class C Plan, each Fund pays Mitchell Hutchins a
distribution fee, accrued daily and payable monthly, at the annual rate of
0.50% of the average daily net assets of the Class C 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 a Fund under the Plan shall not be materially increased without the
affirmative vote of the holders of a majority of the outstanding shares of the
relevant Class and (4) while the Plan remains in effect, the selection and
nomination of trustees who are not "interested persons" of the Trust shall be
committed to the discretion of the trustees who are not "interested persons" of
the Trust.
In reporting amounts expended under the Plans to the trustees, Mitchell
Hutchins will allocate expenses attributable to the sale of each Class of Fund
shares to such Class based on the ratio of sales of such Class to the sales of
all three Classes of shares. The fees paid by one Class of Fund shares will not
be used to subsidize the sale of any other Class of Fund shares.
For the fiscal year ended November 30, 1995, the Funds paid (or accrued) the
following fees to Mitchell Hutchins under the Class A, Class B and Class C
Plans:
<TABLE>
<CAPTION>
LOW
DURATION INVESTMENT
U.S. GOVERNMENT INCOME GRADE HIGH INCOME
INCOME FUND FUND INCOME FUND FUND
--------------- ---------- ----------- -----------
<S> <C> <C> <C> <C>
Class A................... $1,010,288 $ 339,903 $660,995 $ 658,053
Class B................... 897,787 106,689 722,217 2,336,921
Class C................... 434,110 1,648,558 310,949 848,445
</TABLE>
34
<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 Funds during the fiscal year ended November 30,
1995:
CLASS A
<TABLE>
<CAPTION>
LOW
DURATION INVESTMENT
U.S. GOVERNMENT INCOME GRADE HIGH INCOME
INCOME FUND FUND INCOME FUND FUND
--------------- ---------- ----------- -----------
<S> <C> <C> <C> <C>
Marketing and advertis-
ing..................... $ 79,987 $ 273,013 $ 64,609 $ 66,700
Printing of prospectuses
and statements of
additional information.. 661 794 490 537
Branch network costs
allocated and interest
expense................. 1,037,098 1,106,705 463,908 557,069
Service fees paid to
investment executives... 454,630 152,957 297,448 296,123
</TABLE>
CLASS B
<TABLE>
<CAPTION>
INVESTMENT
U.S. GOVERNMENT LOW DURATION GRADE HIGH INCOME
INCOME FUND INCOME FUND INCOME FUND FUND
--------------- ------------ ----------- -----------
<S> <C> <C> <C> <C>
Marketing and advertis-
ing.................... $ 138,340 $ 90,544 $ 84,202 $ 155,680
Amortization of commis-
sions.................. 467,264 61,239 338,598 1,207,701
Printing of prospectuses
and statements of
additional information. 1,142 264 642 1,215
Branch network costs
allocated and interest
expense................ 1,625,399 398,080 664,703 1,550,931
Service fees paid to
investment executives.. 101,000 12,003 81,251 262,904
</TABLE>
CLASS C
<TABLE>
<CAPTION>
INVESTMENT
U.S. GOVERNMENT LOW DURATION GRADE HIGH INCOME
INCOME FUND INCOME FUND INCOME FUND FUND
--------------- ------------ ----------- -----------
<S> <C> <C> <C> <C>
Marketing and advertis-
ing.................... $ 80,284 $ 407,685 $ 74,751 $ 135,045
Amortization of commis-
sions.................. 116,418 467,016 69,150 159,408
Printing of prospectuses
and statements of
additional information. 663 1,186 557 1,074
Branch network costs
allocated and interest
expense................ 950,363 2,487,562 494,093 1,128,112
Service fees paid to
investment executives.. 65,116 247,284 46,643 127,266
</TABLE>
35
<PAGE>
"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
each Fund's shares, including the PaineWebber retail branch system.
In approving the Funds' overall Flexible PricingSM system of distribution,
the Trust's board of trustees considered several factors, including that
implementation of Flexible Pricing would (1) enable investors to choose the
purchasing option best suited to their individual situation, thereby
encouraging current shareholders to make additional investments in the Funds
and attracting new investors and assets to the Funds to the benefit of each
Fund and its shareholders, (2) facilitate distribution of the Funds' shares
and (3) maintain the competitive position of the Funds in relation to other
funds that have implemented or are seeking to implement similar distribution
arrangements.
In approving the Class A Plan for each Fund, the trustees considered all the
features of the distribution system, including (1) the conditions under which
initial sales charges would be imposed and the amount of such charges, (2)
Mitchell Hutchins' belief that the initial sales charge combined with a
service fee would be attractive to PaineWebber investment executives and
correspondent firms, resulting in greater growth of the Fund than might
otherwise be the case, (3) the advantages to the shareholders of economies of
scale resulting from growth in the Fund's assets and potential 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 each 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 C Plan for each Fund, the trustees considered all the
features of the distribution system, including (1) the advantage to investors
in having no initial sales charges
36
<PAGE>
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 for shares held more than one year 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 C shares on an ongoing basis, along with
continuing service fees, while their customers invest their entire purchase
payments immediately in Class C shares and generally 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 C
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 Hutchins would receive service, distribution and advisory fees that
are calculated based upon a percentage of the average net assets of each Fund,
which fees would increase if the Plan were successful and the Funds attained
and maintained significant asset levels.
Under the Distribution Contract between the Trust and Mitchell Hutchins for
the Class A shares and similar prior distribution contracts, for the periods
set forth below, Mitchell Hutchins earned the following approximate amounts of
sales charges and retained the following approximate amounts, net of
concessions to PaineWebber as exclusive dealer:
U.S. GOVERNMENT INCOME FUND
<TABLE>
<CAPTION>
FISCAL YEARS ENDED NOVEMBER 30,
-------------------------------------------
1993 1994 1995
-------------------------- -------- -------
<S> <C> <C> <C>
Earned.................. $ 555,888 $121,124 $41,959
Retained................ 48,390 10,336 3,492
LOW DURATION INCOME FUND
<CAPTION>
FOR THE PERIOD MAY 3, 1993 FISCAL YEARS ENDED
(COMMENCEMENT OF NOVEMBER 30,
OPERATIONS) TO --------------------
NOVEMBER 30, 1993 1994 1995
-------------------------- -------- -------
<S> <C> <C> <C>
Earned.................. $5,336,484 $892,216 $ 5,994
Retained................ 31,294 494,591 3,637
</TABLE>
37
<PAGE>
INVESTMENT GRADE INCOME FUND
<TABLE>
<CAPTION>
FISCAL YEARS ENDED
NOVEMBER 30,
----------------------------
1993 1994 1995
---------- -------- --------
<S> <C> <C> <C>
Earned....................................... $ 255,824 $137,013 $ 48,610
Retained..................................... 19,389 79,808 28,121
HIGH INCOME FUND
<CAPTION>
FISCAL YEARS ENDED
NOVEMBER 30,
----------------------------
1993 1994 1995
---------- -------- --------
<S> <C> <C> <C>
Earned....................................... $1,443,963 $793,898 $297,694
Retained..................................... 104,383 55,058 18,982
</TABLE>
For the fiscal year ended November 30, 1995, Mitchell Hutchins earned and
retained the following contingent deferred sales charges paid upon certain
redemptions of Class A, Class B and Class C shares:
<TABLE>
<CAPTION>
U.S. GOVERNMENT LOW DURATION INVESTMENT HIGH
INCOME FUND INCOME FUND INCOME FUND INCOME FUND
--------------- ------------ ----------- -----------
<S> <C> <C> <C> <C>
Class A................. $ 0 $ 0 $ 0 $ 0
Class B................. 473,452 74,147 276,271 1,194,903
Class C................. 0 0 0 0
</TABLE>
PORTFOLIO TRANSACTIONS
Subject to policies established by the Trust's board of trustees, Mitchell
Hutchins or PIMCO, as applicable, is responsible for the execution of each
Fund's portfolio transactions and the allocation of brokerage transactions. In
executing portfolio transactions, Mitchell Hutchins and PIMCO seek to obtain
the best net results for a 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 that time. While Mitchell Hutchins or
PIMCO generally seeks reasonably competitive commission rates, payment of the
lowest commission is not necessarily consistent with obtaining the best net
results. During the fiscal year ended November 30, 1995, no Fund paid any
brokerage commissions. During the fiscal year ended November 30, 1994, U.S.
Government Income Fund, Low Duration Income Fund, Investment Grade Income Fund
and High Income Fund paid approximately $0, $88,421, $21,500 and $74,838,
respectively, in brokerage commissions. During the fiscal year ended November
30, 1993, U.S. Government Income Fund and Investment Grade Income Fund paid no
brokerage commissions and High Income Fund paid approximately $4,145 in
brokerage commissions. During the period May 3, 1993 (commencement of
operations) to November 30, 1993, Low Duration Income Fund paid no brokerage
commissions.
No Fund has any obligation to deal with any broker or group of brokers in the
execution of portfolio transactions. The Funds contemplate that, consistent
with the policy of obtaining the best
38
<PAGE>
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 are members of a national
securities exchange to effect portfolio transactions for the Funds on such
exchange and to retain compensation in connection with such transactions. Any
such transactions will be effected and related compensation paid in accordance
with applicable SEC regulations. During the fiscal year ended November 30,
1995, no Fund paid any brokerage commissions to PaineWebber or any other
affiliate of Mitchell Hutchins. During the fiscal year ended November 30, 1994,
High Income Fund paid approximately $30,915 in brokerage commissions to
PaineWebber. During the fiscal years ended November 30, 1994 and November 30,
1993, the Funds paid no other 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. Each
Fund's procedures in selecting FCMs to execute that 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 a Fund and subject to the review of the
Trust's board of trustees, Mitchell Hutchins or PIMCO may cause a Fund to
purchase and sell portfolio securities through brokers which provide the Fund
with research, analysis, advice and similar services. In return for such
services, the Fund may pay to those brokers a higher commission than may be
charged by other brokers, provided that Mitchell Hutchins or PIMCO determines
in good faith that such commission is reasonable in terms either of that
particular transaction or of the overall responsibility of Mitchell Hutchins or
PIMCO to that 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. During the fiscal year ended November 30, 1995, the Funds directed
no portfolio transactions to brokers chosen because they provided research
services.
For purchases or sales with broker-dealer firms which act as principal,
Mitchell Hutchins and PIMCO seek best execution. Although Mitchell Hutchins or
PIMCO may receive certain research or execution services in connection with
these transactions, neither will 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, neither
Mitchell Hutchins nor PIMCO will enter into any explicit soft dollar
arrangements relating to principal transactions or receive in principal
transactions the types of services which could be purchased for hard dollars.
Mitchell Hutchins and 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 Mitchell Hutchins or PIMCO
receiving multiple quotes from dealers before executing the transaction on an
agency basis.
39
<PAGE>
Information and research services furnished by brokers or dealers through
which or with which a Fund effects securities transactions may be used by
Mitchell Hutchins or PIMCO in advising other funds or accounts and, conversely,
research services furnished to Mitchell Hutchins or PIMCO by dealers or brokers
in connection with other funds or accounts Mitchell Hutchins or PIMCO advises
may be used by Mitchell Hutchins or PIMCO in advising the Fund. Information and
research received from such brokers or dealers will be in addition to, and not
in lieu of, the services required to be performed by Mitchell Hutchins under
the Advisory Contract or PIMCO under the Sub-Advisory Contract.
Investment decisions for the Funds and other investment accounts managed by
Mitchell Hutchins or 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 involved 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 a 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 Funds will not purchase securities that are offered in underwritings in
which Mitchell Hutchins or any of its affiliates is a member of the
underwriting or selling group except pursuant to procedures adopted by the
Trust's board of trustees pursuant to Rule 10f-3 under the 1940 Act. Among
other things, these procedures require that the commission or spread paid in
connection with such a purchase be reasonable and fair, that the purchase be at
not more than the public offering price prior to the end of the first business
day after the date of the public offering and that Mitchell Hutchins or any
affiliate thereof not participate in or benefit from the sale to the Fund.
PORTFOLIO TURNOVER. Each Fund's annual portfolio turnover rate may vary
greatly from year to year, but it will not be a limiting factor when management
deems portfolio changes appropriate. The portfolio turnover rate is calculated
by dividing the lesser of a 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
the securities in the portfolio during the year. During the fiscal years ended
November 30, 1995 and November 30, 1994, respectively, the portfolio turnover
rates were 206% and 358% for U.S. Government Income Fund; 242% and 246% for Low
Duration Income Fund; 149% and 142% for Investment Grade Income Fund; and 94%
and 156% for High Income Fund.
REDUCED SALES CHARGES, ADDITIONAL EXCHANGE AND
REDEMPTION INFORMATION AND OTHER SERVICES
COMBINED PURCHASE PRIVILEGE--CLASS A SHARES. Investors and eligible groups of
related Fund investors may combine purchases of Class A shares of the Funds
with concurrent purchases of Class A shares of any other PaineWebber mutual
fund and thus take advantage of the reduced sales charges for Class A shares
indicated in the table of sales charges in the Prospectus. The sales charge
40
<PAGE>
payable on the purchase of Class A shares of the Funds 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).
(h) individual accounts related together under one registered investment
adviser having full discretion and control over the accounts. The
registered investment adviser must communicate at least quarterly through a
newsletter or investment update establishing a relationship with all of the
accounts.
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 Funds 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 mutual fund.
The purchaser must provide sufficient information to permit confirmation of his
or her holdings, and the acceptance of the purchase order is subject to such
confirmation. The right of accumulation may be amended or terminated at any
time.
WAIVERS OF SALES CHARGES--CLASS B SHARES. Among other circumstances, the
contingent deferred sales charge on Class B shares is waived where a total or
partial redemption is made within one year following the death of the
shareholder. The contingent deferred sales charge waiver is available where the
decedent is either the sole shareholder or owns the shares with his or her
spouse as a joint tenant with right of survivorship. This waiver applies only
to redemption of shares held at the time of death.
Certain PaineWebber mutual funds offered shares subject to contingent
deferred sales charges before the implementation of the Flexible Pricing system
on July 1, 1991 ("CDSC Funds"). The
41
<PAGE>
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 a 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 Funds may be exchanged for shares of the
corresponding Class of most other PaineWebber 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 a 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 which make cash payments undesirable, each 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
redemption 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
a 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. A 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 a 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 a 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 a Fund of sufficient
Fund shares to provide the withdrawal payment specified by participants in the
Funds' 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 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
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<PAGE>
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
without a sales charge. Shareholders may exercise the reinstatement privilege
by notifying the Transfer Agent of such desire and forwarding a check for the
amount to be purchased within 365 days after the date of redemption. The
reinstatement will be made at the net asset value per share next computed after
the notice of reinstatement and check are received. The amount of a purchase
under this reinstatement privilege cannot exceed the amount of the redemption
proceeds. Gain on a redemption is taxable regardless of whether the
reinstatement privilege is exercised; however, a loss arising out of a
redemption will not be deductible to the extent the redemption proceeds are
reinvested, if the reinstatement privilege is exercised within 30 days after
redemption, and an adjustment will be made to the shareholder's tax basis for
the shares acquired pursuant to the reinstatement privilege. Gain or loss on a
redemption also will be adjusted for federal income tax purposes by the amount
of any sales charge paid on Class A shares, under the circumstances and to the
extent described in "Dividends and Taxes" in the Prospectus.
PAINEWEBBER RMA RESOURCE ACCUMULATION PLANSM; PAINEWEBBER RESOURCE MANAGEMENT
ACCOUNT(R) (RMA(R)).
Shares of the PaineWebber mutual funds (each a "PW Fund" and, collectively,
the "PW Funds") are available for purchase by customers of PaineWebber and its
correspondent firms who maintain Resource Management Accounts ("RMA
accountholders") through the RMA Resource Accumulation Plan ("Plan"). 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 three Business Days (defined under "Valuation
of Shares") after the trade date, and the purchase price of the shares is
withdrawn from the investor's RMA account on the settlement date from the
following sources and in the following order: uninvested cash balances,
balances in RMA money market funds, or margin borrowing power, if applicable to
the account.
To participate in the Plan, an investor must be an RMA accountholder, must
have made an initial purchase of the shares of each PW Fund selected for
investment under the Plan (meeting applicable minimum investment requirements)
and must complete and submit the RMA Resource Accumulation Plan Client
Agreement and Instruction Form available from PaineWebber. The investor must
have received a current prospectus for each PW Fund selected prior to enrolling
in the Plan. Information about mutual fund positions and outstanding
instructions under the Plan are noted on the RMA accountholder's account
statement. Instructions under the Plan may be changed at any time, but may take
up to two weeks to become effective.
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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 realized and
unrealized 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 accountholder's choice of
the seven RMA money market funds--RMA Money Market Portfolio, RMA U.S.
Government Portfolio, RMA Tax-Free Fund, RMA California Municipal Money
Fund, RMA Connecticut Municipal Money Fund, RMA New Jersey 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;
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<PAGE>
. 24-hour access to account information through toll-free numbers, and more
detailed personal assistance during business hours from the RMA Service
Center;
. expanded account protection to $25 million in the event of the
liquidation of PaineWebber. This protection does not apply to shares of
the RMA money market funds or the PW Funds because those shares are held
at the transfer agent and not through PaineWebber; and
. automatic direct deposit of checks into the investor's RMA account and
automatic withdrawals from the account.
The annual account fee for an RMA account is $85, which includes the Gold
MasterCard, with an additional fee of $40 if the investor selects an optional
line of credit with the Gold MasterCard.
CONVERSION OF CLASS B SHARES
Class B shares of each Fund automatically convert to Class A shares of that
Fund, based on the relative net asset value per share of each of the two
Classes, as of the close of business on the first Business Day (as defined
below) of the month in which the sixth anniversary of the initial issuance of
such Class B shares of the Fund occurs. For the purpose of calculating the
holding period required for conversion of Class B shares, the date of initial
issuance shall mean (1) the date on which such Class B shares were issued, or
(2) for Class B shares obtained through an exchange, or a series of exchanges,
the date on which the original Class B shares were issued. If a shareholder
acquired Class B shares of a 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 is determined based on the date the CDSC Fund
shares were initially issued. For purposes of conversion to 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 convert to Class A
shares. The portion is determined by the ratio that the shareholder's Class B
shares converting to Class A bears to the shareholder's total Class B shares
not acquired through dividends and other distributions.
The availability of the conversion feature is subject to (1) the continuing
applicability of a ruling of the Internal Revenue Service that the dividends
and other distributions paid on Class A and Class B shares will not result in
"preferential dividends" under the Internal Revenue Code and (2) the continuing
availability of an opinion of counsel to the effect that the conversion of
shares does not constitute a taxable event. If the conversion feature ceased to
be available, the Class B shares 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
Each Fund determines the 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 Mitchell Hutchins or PIMCO, the fair value of the
security. Where such market quotations are not readily available, securities
are valued based upon appraisals received from a pricing service using a
computerized matrix system or based upon appraisals 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. All other securities or assets will be valued at fair value as
determined in good faith by or under the direction of the Trust's board of
trustees. All investments of High Income Fund that are quoted in foreign
currency are valued daily in U.S. dollars on the basis of the foreign currency
exchange rate prevailing at the time such valuation is determined by the Fund's
custodian.
Foreign currency exchange rates are generally determined prior to the close
of trading on the NYSE. Occasionally events affecting the value of foreign
investments and such exchange rates occur between the time at which they are
determined and the close of trading on the NYSE, which events will not be
reflected in a computation of High Income Fund's net asset value on that day.
If events materially affecting the value of such investments or currency
exchange rates occur during such time period, the investments will be valued at
their fair value by or under the direction of the Trust's board of trustees.
The foreign currency exchange transactions of High Income Fund conducted on a
spot (that is, cash) basis are valued at the spot rate for purchasing or
selling currency prevailing on the foreign exchange market. This rate under
normal conditions differs from the prevailing exchange rate in an amount
generally less than one-tenth of one percent due to the costs of converting
from one currency to another.
PERFORMANCE INFORMATION
Each 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. Average annual total return quotes ("Standardized Return") used
in a 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.
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<PAGE>
Under the foregoing formula, the time periods used in Performance
Advertisements will be based on rolling calendar quarters, updated to the last
day of the most recent quarter prior to submission of the advertisement for
publication. Total return, or "T" in the formula above, is computed by finding
the average annual change in the value of an initial $1,000 investment over the
period. In calculating the ending redeemable value for Class A shares, the
maximum 4% sales charge (3% for Low Duration Income Fund) is deducted from the
initial $1,000 payment and, for Class B and Class C shares, the applicable
contingent deferred sales charge imposed on a redemption of Class B and Class C
shares held for the period is deducted. All dividends and other distributions
are assumed to have been reinvested at net asset value.
Each 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"). Each Fund calculates Non-Standardized Return
for specified periods of time by assuming an investment of $1,000 in Fund
shares and assuming the reinvestment of all dividends and other distributions.
The rate of return is determined by subtracting the initial value of the
investment from the ending value and by dividing the remainder by the initial
value. Neither initial nor contingent deferred sales charges are taken into
account in calculating Non-Standardized Return; the inclusion of these charges
would reduce the return.
Both Standardized Return and Non-Standardized Return for Class B shares for
periods of over six years will reflect conversion of the Class B shares to
Class A shares at the end of the sixth year.
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<PAGE>
The following table shows performance information for the Class A, Class B
and Class C (formerly Class D) shares of the Funds for the periods indicated.
All returns for periods of more than one year are expressed as an average
annual return:
<TABLE>
<CAPTION>
U.S. GOVERNMENT LOW DURATION INVESTMENT GRADE
INCOME FUND INCOME FUND INCOME FUND HIGH INCOME FUND
----------------------- ----------------------- ----------------------- -----------------------
CLASS A CLASS B CLASS C CLASS A CLASS B CLASS C CLASS A CLASS B CLASS C CLASS A CLASS B CLASS C
------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Fiscal year ended
November 30, 1995:
Standardized
Return*.......... 10.16% 8.81% 13.37% 6.92% 6.30% 8.85% 14.23% 12.97% 17.62% 4.61% 3.05% 7.70%
Non-Standardized
Return........... 14.70% 13.81% 14.12% 10.25% 9.30% 9.60% 18.95% 17.97% 18.37% 9.01% 8.05% 8.45%
Inception** to
November 30, 1995:
Standardized
Return*.......... 8.20% 4.63% 2.89% 1.51% 1.19% 2.21% 10.12% 8.71% 7.52% 10.16% 11.27% 7.00%
Non-Standardized
Return........... 8.60% 5.01% 2.89% 2.76% 1.95% 2.21% 10.53% 9.05% 7.52% 10.56% 11.59% 7.00%
Five years ended
November 30, 1994:
Standardized
Return*.......... 5.60% NA NA NA NA NA 9.27% NA NA 16.77% NA NA
Non-Standardized
Return........... 6.45% NA NA NA NA NA 10.17% NA NA 17.71% NA NA
Ten years ended
November 30, 1995:
Standardized
Return*.......... 6.96% NA NA NA NA NA 8.46% NA NA 8.96% NA NA
Non-Standardized
Return........... 7.39% NA NA NA NA NA 8.90% NA NA 9.41% NA NA
</TABLE>
- --------
*All Standardized Return figures for Class A shares reflect deduction of the
current maximum sales charge of 4% (3% for Low Duration Income Fund). All
Standardized Return figures for Class B and Class C shares reflect deduction
of the applicable contingent deferred sales charges imposed on a redemption
of shares held for the period.
**For U.S. Government Income Fund, Investment Grade Income Fund and High Income
Fund, the inception dates for each Class were as follows: Class A shares--
August 31, 1984; Class B shares--July 1, 1991; and Class C shares--July 2,
1992. For Low Duration Income Fund, the inception date for its Class A,
Class B and Class C shares was May 3, 1993.
YIELD. Yields used in each 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)
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or the net asset value per share (in the case of Class B and Class C shares) at
the end of the Period. Yield quotations are calculated according to the
following formula:
a-b
YIELD = 2[( --- + 1)/6/ - 1]
cd
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 C shares) on the last day of the Period
Except as noted below, in determining net investment income earned during the
Period (variable "a" in the above formula), each 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 Funds' current maximum 4% (3% for Low Duration Income Fund)
initial sales charge on Class A shares is included.
The following table shows the yield for the Class A, Class B and Class C
shares of each Fund for the 30-day period ended November 30, 1995.
<TABLE>
<CAPTION>
U.S. GOVERNMENT LOW DURATION INVESTMENT GRADE HIGH INCOME
INCOME FUND INCOME FUND INCOME FUND FUND
--------------- ------------ ---------------- -----------
<S> <C> <C> <C> <C>
Class A........... 5.57% 5.80% 6.69% 12.12%
Class B........... 5.01% 5.11% 6.23% 11.85%
Class C........... 5.28% 5.36% 6.47% 12.10%
</TABLE>
OTHER INFORMATION. In Performance Advertisements, each Fund may compare its
Standardized Return and/or its Non-Standardized Return with data published by
Lipper Analytical Services, Inc. ("Lipper") for U.S. government funds (U.S.
Government Income Fund and Low Duration Income Fund), corporate bond (BBB)
funds (Investment Grade Income Fund) and high yield funds (High Income Fund);
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
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<PAGE>
Salomon Brothers Bond Index, First Boston High Yield Index, Merrill Lynch High
Yield Indices, Lehman Bond Index, Lehman Government/Corporate Bond Index, the
Standard & Poor's 500 Composite Stock Price Index ("Standard & Poor's 500"),
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. Each 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 Funds and
comparative mutual fund data and ratings reported in independent periodicals,
including (but not limited to) THE WALL STREET JOURNAL, MONEY Magazine, FORBES,
BUSINESS WEEK, FINANCIAL WORLD, BARRON'S, FORTUNE, THE NEW YORK TIMES, THE
CHICAGO TRIBUNE, THE WASHINGTON POST and THE KIPLINGER LETTERS. Comparisons in
Performance Advertisements may be in graphic form.
A 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 by being
paid in additional Fund shares, any future income or capital appreciation of
the Fund would increase the value, not only of the original Fund investment,
but also of the additional Fund shares received through reinvestment. As a
result, the value of the Fund investment would increase more quickly than if
dividends or other distributions had been paid in cash.
The Funds may also compare their performance with, or may otherwise discuss,
the performance of bank certificates of deposit (CDs) as measured by the CDA
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 a Fund or its performance to CDs or CD performance,
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. Fund
shares are not insured or guaranteed by the U.S. government and returns thereon
and net asset values will fluctuate. The securities held by the Funds generally
have longer maturities than most CDs and may reflect interest rate fluctuations
for longer term securities. An investment in a 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, each Fund must distribute to
its shareholders for each taxable year at least 90% of its investment company
taxable income (consisting generally of net investment income, net short-term
capital gain and, for High Income Fund, net gains from certain foreign currency
transactions) ("Distribution Requirement") and must meet several additional
requirements. With respect to each Fund, these requirements include the
following: (1) the Fund must derive at least 90% of its gross income each
taxable year from dividends, interest, payments with respect to
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<PAGE>
securities loans and gains from the sale or other disposition of securities or
foreign currencies, or other income (including gains from options, futures or
forward currency contracts) derived with respect to its business of investing
in securities or those currencies ("Income Requirement"); (2) the Fund must
derive less than 30% of its gross income each taxable year from the sale or
other disposition of securities, or any of the following, that were held for
less than three months--options or futures (other than those on foreign
currencies), or foreign currencies (or options, futures or forward contracts
thereon) that are not directly related to the Fund's principal business of
investing in securities (or options and futures with respect to securities)
("Short-Short Limitation"); (3) at the close of each quarter of the Fund's
taxable year, at least 50% of the value of its total assets must be represented
by cash and cash items, U.S. government securities, securities of other RICs
and other securities that are 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 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 a Fund in November or December
of any year and payable to shareholders of record on a date in either 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.
U.S. Government Income Fund and Low Duration Income Fund each invests
exclusively in debt securities and receives no dividend income; accordingly, no
portion of the dividends or other distributions paid by these Funds is eligible
for the dividends-received deduction allowed to corporations. Although High
Income Fund and Investment Grade Income Fund are authorized to hold equity
securities, it is expected that any dividend income received by the Funds will
be minimal.
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.
Interest and dividends, if any, received by High Income Fund may be subject
to income, withholding or other taxes imposed by foreign countries and U.S.
possessions that would reduce the yield on its securities. Tax conventions
between certain countries and the United States, however, may reduce or
eliminate these foreign taxes, and many foreign countries do not impose taxes
on capital gains in respect of investments by foreign investors.
Each Fund will be subject to a nondeductible 4% excise tax ("Excise Tax") to
the extent it fails to distribute by the end of any calendar year substantially
all of its ordinary income for that year and capital gain net income for the
one-year period ending on November 30 of that year, plus certain other amounts.
The use of hedging and option income strategies, such as writing (selling)
and purchasing options and futures and entering into forward currency
contracts, involves complex rules that will
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<PAGE>
determine for income tax purposes the character and timing of recognition of
the gains and losses a Fund realizes in connection therewith. Gains from the
disposition of foreign currencies (except certain gains therefrom that may be
excluded by future regulations), and gains from options, futures and forward
currency contracts derived by a Fund with respect to its business of investing
in securities or foreign currencies, will qualify as permissible income under
the Income Requirement. However, income from the disposition of options and
futures (other than those on foreign currencies) will be subject to the Short-
Short Limitation if they are held for less than three months. Income from the
disposition of foreign currencies, and options, futures and forward contracts
on foreign currencies, that are not directly related to a Fund's principal
business of investing in securities (or options and futures with respect to
securities) also will be subject to the Short-Short Limitation if they are held
for less than three months.
If a 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. Each Fund
will consider whether it should seek to qualify for this treatment for its
hedging transactions. To the extent a Fund does not qualify for this treatment,
it may be forced to defer the closing out of certain options, futures and
forward currency contracts beyond the time when it otherwise would be
advantageous to do so, in order for the Fund to continue to qualify as a RIC.
Each Fund may acquire zero coupon or other securities issued with original
issue discount ("OID"). As a holder of such securities, a 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 them during
the year. Similarly, High Income Fund must include in its gross income
securities it receives as "interest" on payment-in-kind securities. Each Fund
has elected similar treatment with respect to securities purchased at a
discount from their face value ("market discount"). Because each Fund annually
must distribute substantially all of its investment company taxable income,
including any accrued OID, market discount and other non-cash income, to
satisfy the Distribution Requirement and avoid imposition of the Excise Tax, a
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 its 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, futures or forward
currency contracts, 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 October 20, 1995, Low
Duration Income Fund was known as "PaineWebber Short-Term U.S. Government
Income Fund." Prior to November 10, 1995, the Class C shares of all four Funds
were called "Class D" shares.
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PaineWebber Managed Investments Trust is an entity of the type commonly known
as a "Massachusetts business trust." Prior to February 26, 1992, the Trust's
name was PaineWebber Fixed Income Portfolios. Under Massachusetts law,
shareholders could, under certain circumstances, be held personally liable for
the obligations of the Trust or a Fund. However, the Trust's Declaration of
Trust disclaims shareholder liability for acts or obligations of the Trust or
the Funds 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, a Fund,
the trustees or any of them in connection with the Trust. The Declaration of
Trust provides for indemnification from each 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 a 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 Fund's 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 each Fund in such a way as to avoid, as far as possible, ultimate liability
of the shareholders for liabilities of the Fund.
CLASS-SPECIFIC EXPENSES. Each Fund might determine to allocate certain
expenses (in addition to distribution fees) to the specific Classes of the
Fund's shares to which those expenses are attributable. For example, Class B
shares bear higher transfer agency fees per shareholder account than those
borne by Class A or Class C shares. The higher fee is imposed due to the higher
costs incurred by the Transfer Agent in tracking shares subject to a contingent
deferred sales charge because, upon redemption, the duration of the
shareholder's investment must be determined in order to determine the
applicable charge. Moreover, the tracking and calculations required by the
automatic conversion feature of the Class B shares will cause the Transfer
Agent to incur additional costs. Although the transfer agency fee will differ
on a per account basis as stated above, the specific extent to which the
transfer agency fees will differ between the Classes as a percentage of net
assets is not certain, because the fee as a percentage of net assets will be
affected by the number of shareholder accounts in each Class and the relative
amounts of net assets in each Class.
COUNSEL. The law firm of Kirkpatrick & Lockhart LLP, 1800 Massachusetts
Avenue, NW, Washington, DC 20036-1800, counsel to the Funds, has passed upon
the legality of the shares offered by the Funds' Prospectus. Kirkpatrick &
Lockhart LLP also acts as counsel to Mitchell Hutchins and PaineWebber in
connection with other matters.
INDEPENDENT AUDITORS. Ernst & Young LLP, 787 Seventh Avenue, New York, New
York 10019, serves as independent auditors for the Trust.
FINANCIAL STATEMENTS
The Funds' Annual Reports to Shareholders for the fiscal year ended November
30, 1995 are separate documents supplied with this Statement of Additional
Information and the financial statements, accompanying notes and reports of
independent auditors appearing therein are incorporated by reference in this
Statement of Additional Information.
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NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS NOT CONTAINED IN THE PROSPECTUS OR IN THIS STATEMENT OF
ADDITIONAL INFORMATION IN CONNECTION WITH THE OFFERING MADE BY THE PROSPECTUS
AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED
UPON AS HAVING BEEN AUTHORIZED BY THE FUNDS OR THEIR DISTRIBUTOR. THE
PROSPECTUS AND THIS STATEMENT OF ADDITIONAL INFORMATION DO NOT CONSTITUTE AN
OFFERING BY THE FUNDS OR BY THE DISTRIBUTOR IN ANY JURISDICTION IN WHICH SUCH
OFFERING MAY NOT LAWFULLY BE MADE.
-----------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Policies and Restrictions...................................... 1
Hedging and Related Income Strategies..................................... 12
Trustees and Officers; Principal Holders of Securities.................... 22
Investment Advisory and Distribution Arrangements......................... 31
Portfolio Transactions.................................................... 38
Reduced Sales Charges, Additional Exchange and Redemption Information and
Other Services........................................................... 40
Conversion of Class B Shares.............................................. 45
Valuation of Shares....................................................... 45
Performance Information................................................... 46
Taxes..................................................................... 50
Other Information......................................................... 52
Financial Statements...................................................... 53
</TABLE>
(C) 1996 PaineWebber Incorporated
[LOGO OF RECYCLED PAPER APPEARS HERE]
PAINEWEBBER
U.S. GOVERNMENT
INCOME FUND
LOW DURATION
U.S. GOVERNMENT INCOME FUND
INVESTMENT GRADE
INCOME FUND
HIGH INCOME FUND
- --------------------------------------------------------------------------------
Statement of Additional Information
April 1, 1996,
as revised May 3, 1996
- --------------------------------------------------------------------------------
PAINEWEBBER
<PAGE>
PAINEWEBBER U.S. GOVERNMENT INCOME FUND
PAINEWEBBER LOW DURATION U.S. GOVERNMENT INCOME FUND
CLASS Y SHARES
1285 AVENUE OF THE AMERICAS
NEW YORK, NEW YORK 10019
STATEMENT OF ADDITIONAL INFORMATION
The two Funds named above (each a "Fund") are diversified series of
PaineWebber Managed Investments Trust ("Trust"), a professionally managed
mutual fund. PaineWebber U.S. Government Income Fund ("U.S. Government Income
Fund") seeks to provide high current income consistent with the preservation of
capital and liquidity and invests primarily in U.S. government securities.
PaineWebber Low Duration U.S. Government Income Fund ("Low Duration Income
Fund") seeks the highest level of current income consistent with the
preservation of capital and low volatility of net asset value; it invests
primarily in U.S. government securities and seeks to limit the volatility of
its net asset value per share by maintaining, under normal circumstances, an
overall portfolio duration of from one to three years. The Funds' 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 exclusive dealer for the sale of Fund
shares. Pacific Investment Management Company ("PIMCO") serves as investment
sub-adviser for Low Duration Income Fund. The Class Y shares described in this
Statement of Additional Information are currently offered for sale primarily to
participants in the INSIGHT Investment Advisory Program ("INSIGHT"), when
purchased through that program. The Class Y shares of U.S. Government Income
Fund also are offered for sale to the trustee of the PaineWebber Savings
Investment Plan acting on behalf of that Plan. This Statement of Additional
Information is not a prospectus and should be read only in conjunction with the
Funds' current Prospectus, dated April 1, 1996. 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. Participants in the PaineWebber Savings
Investment Plan may obtain a copy of the Prospectus by contacting the
PaineWebber Incorporated Benefits Department, 1000 Harbor Boulevard, 10th
Floor, Weehawken, New Jersey 07087 or by calling 1-201-902-4444. This Statement
of Additional Information is dated April 1, 1996, as revised May 3, 1996.
INVESTMENT POLICIES AND RESTRICTIONS
The following supplements the information contained in the Prospectus
concerning the investment policies and limitations of the Funds.
YIELD FACTORS AND RATINGS. Standard & Poor's, a division of The McGraw Hill
Companies, Inc. ("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 Funds may use these ratings
in determining whether to purchase, sell or hold a security.
<PAGE>
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 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 indicates. 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 a 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.
In addition to ratings assigned to individual bond issues, Mitchell Hutchins
or PIMCO, as applicable, 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 Funds invest, 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 bonds, both within a particular
classification and between classifications. An issuer's obligations under its
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 on their bonds.
SPECIAL CHARACTERISTICS OF MORTGAGE- 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,
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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.
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 a Fund.
The Funds 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 rates, ARMs generally do not increase in value
3
<PAGE>
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 payments. If the monthly payment
exceeds the sum of the interest accrued at the applicable 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, 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.
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.
ILLIQUID SECURITIES. U.S. Government Income Fund may invest up to 10% of its
net assets and Low Duration Income Fund may invest up to 15% of its net assets
in illiquid securities. The term "illiquid securities" for this purpose means
securities that cannot be disposed of within seven days in the ordinary course
of business at approximately the amount at which a Fund has valued the
securities and includes, among other things, purchased over-the-counter ("OTC")
options,
4
<PAGE>
repurchase agreements maturing in more than seven days and restricted
securities other than those Mitchell Hutchins or PIMCO has determined are
liquid pursuant to guidelines established by the Trust's board of trustees. The
assets used as cover for OTC options written by a 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, a Fund may be obligated to pay
all or part of the registration expenses and a considerable period may elapse
between the time of the decision to sell and the time the Fund may be permitted
to sell a security under an effective registration statement. If, during such a
period, adverse market conditions were to develop, the Fund might obtain a less
favorable price than prevailed when it decided to sell.
Not all restricted securities are illiquid. In recent years a large
institutional market has developed for certain securities that are not
registered under the 1933 Act, including private placements, repurchase
agreements, commercial paper, foreign securities and corporate bonds and notes.
These instruments are often restricted securities because the securities are
sold in transactions not requiring registration. Institutional investors
generally will not seek to sell these instruments to the general public, but
instead will often depend either on an efficient institutional market in which
such unregistered securities can be readily resold or on an issuer's ability to
honor a demand for repayment. Therefore, the fact that there are contractual or
legal restrictions on resale to the general public or certain institutions is
not dispositive of the liquidity of such investments.
Rule 144A under the 1933 Act establishes a "safe harbor" from the
registration requirements of the 1933 Act for resales of certain securities to
qualified institutional buyers. Institutional markets for restricted securities
have developed as a result of Rule 144A, providing both readily ascertainable
values for restricted securities and the ability to liquidate an investment to
satisfy share redemption orders. Such markets include automated systems for the
trading, clearance and settlement of unregistered securities of domestic and
foreign issuers, such as the PORTAL System sponsored by the National
Association of Securities Dealers, Inc. An insufficient number of qualified
institutional buyers interested in purchasing Rule 144A-eligible restricted
securities held by a 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 reasonable prices.
The Trust's board of trustees has delegated the function of making day-to-day
determinations of liquidity to Mitchell Hutchins or PIMCO, pursuant to
guidelines approved by the board. Mitchell Hutchins and PIMCO take 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 offers are solicited and the mechanics of
transfer). Mitchell Hutchins or PIMCO monitors the liquidity of restricted
securities in the Fund's portfolio and reports periodically on such decisions
to the board of trustees.
5
<PAGE>
REPURCHASE AGREEMENTS. Repurchase agreements are transactions in which a 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. A 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 a
Fund upon their acquisition is accrued as interest and included in the Fund's
net investment income.
Repurchase agreements carry certain risks not associated with direct
investments in securities, including possible declines in the market value of
the underlying securities and delays and costs to a Fund if the other party to
a repurchase agreement becomes insolvent. Each Fund intends to enter into
repurchase agreements only with banks and dealers in transactions believed by
Mitchell Hutchins or PIMCO to present minimum credit risks in accordance with
guidelines established by the Trust's board of trustees. Mitchell Hutchins or
PIMCO reviews and monitors the creditworthiness of those institutions under the
board's general supervision.
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. As stated in the Prospectus,
each 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 a
Fund's net asset value. When a 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 Funds purchase when-issued securities only with the intention of taking
delivery, but may sell the right to acquire the security prior to delivery if
Mitchell Hutchins or PIMCO deems it advantageous to do so, which may result in
capital gain or loss to a Fund.
LENDING OF PORTFOLIO SECURITIES. As indicated in the Prospectus, each Fund is
authorized to lend up to 33 1/3% of the total value of its portfolio securities
to broker-dealers or institutional investors that Mitchell Hutchins deems
qualified, but only when the borrower maintains acceptable collateral with the
Fund's custodian, marked to market daily, in an amount at least equal to the
market value of the securities loaned, plus accrued interest and dividends.
Acceptable collateral is limited to cash, U.S. government securities and
irrevocable letters of credit that meet certain guidelines established by
Mitchell Hutchins. In determining whether to lend securities to a particular
broker-dealer or institutional investor, Mitchell Hutchins will consider, and
during the period of the loan will monitor, all relevant facts and
circumstances, including the creditworthiness of the borrower. A Fund will
retain authority to terminate any loan at any time. A 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. A Fund will
receive reasonable interest on the loan or a flat fee from
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<PAGE>
the borrower and amounts equivalent to any dividends, interest or other
distributions on the securities loaned. A 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 a 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. Each Fund will not:
(1) purchase securities of any one issuer if, as a result, more than 5% of
the Fund's total assets would be invested in securities of that issuer
or the Fund would own or hold more than 10% of the outstanding voting
securities of that issuer, except that up to 25% of the Fund's total
assets may be invested without regard to this limitation, and except
that this limitation does not apply to securities issued or guaranteed
by the U.S. government, its agencies and instrumentalities or to
securities issued by other investment companies.
The following interpretation applies to, but is not a part of, this
fundamental restriction: Mortgage- and asset-backed securities will not
be considered to have been issued by the same issuer by reason of the
securities having the same sponsor, and mortgage- and asset-backed
securities issued by a finance or other special purpose subsidiary that
are not guaranteed by the parent company will be considered to be
issued by a separate issuer from the parent company.
(2) purchase any security if, as a result of that purchase, 25% or more of
the Fund's total assets would be invested in securities of issuers
having their principal business activities in the same industry, except
that this limitation does not apply to securities issued or guaranteed
by the U.S. government, its agencies or instrumentalities or to
municipal securities, and except that the Fund, under normal
circumstances, will invest 25% or more of its total assets 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.
(3) issue senior securities or borrow money, except as permitted under the
Investment Company Act of 1940 ("1940 Act") and then not in excess of
33 1/3% of the Fund's total assets (including the amount of the senior
securities issued but reduced by any liabilities not constituting
senior securities) at the time of the issuance or borrowing, except
that the Fund may borrow up to an additional 5% of its total assets
(not including the amount borrowed) for temporary or emergency
purposes.
(4) make loans, except through loans of portfolio securities or through
repurchase agreements, provided that for purposes of this restriction,
the acquisition of bonds, debentures, other debt securities or
instruments, or participations or other interests therein and
investments
7
<PAGE>
in government obligations, commercial paper, certificates of deposit,
bankers' acceptances or similar instruments will not be considered the
making of a loan.
(5) engage in the business of underwriting securities of other issuers,
except to the extent that the Fund might be considered an underwriter
under the federal securities laws in connection with its disposition of
portfolio securities.
(6) purchase or sell real estate, except that investments in securities of
issuers that invest in real estate and investments in mortgage-backed
securities, mortgage participations or other instruments supported by
interests in real estate are not subject to this limitation, and except
that the Fund may exercise rights under agreements relating to such
securities, including the right to enforce security interests and to
hold real estate acquired by reason of such enforcement until that real
estate can be liquidated in an orderly manner.
(7) purchase or sell physical commodities unless acquired as a result of
owning securities or other instruments, but the Fund may purchase, sell
or enter into financial options and futures, forward and spot currency
contracts, swap transactions and other financial contracts or
derivative instruments.
The foregoing fundamental investment limitations cannot be changed for a Fund
without the affirmative vote of the lesser of (1) more than 50% of the
outstanding shares of the Fund or (2) 67% or more of the shares of the Fund
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, later
changes in percentage resulting from a change in values of portfolio securities
or the amount of total assets will not be considered a violation of any of the
Funds' investment limitations, restrictions or investment policies.
The following investment restrictions of each Fund are not fundamental and
may be changed by the Trust's board of trustees without shareholder approval.
Each Fund will not:
(1) purchase or retain the securities of any issuer if the officers and
trustees of the Trust and the officers and directors of Mitchell
Hutchins (and, for Low Duration Income Fund, 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 (for Low Duration Income Fund, any security other
than mortgage- and asset-backed securities) if as a result more than 5%
of the value of the Fund's assets would be invested in securities of
companies that, together with any predecessors, have been in continuous
operation for less then three years.
(3) invest more than 10% (for Low Duration Income Fund, 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.
(4) make investments in warrants if such investments, valued at the lower
of cost or market, exceed 5% of the value of its net assets, which
amount may include warrants that are not
8
<PAGE>
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.
(5) invest in real estate limited partnerships.
(6) change its investment policies to permit the Fund to invest more than
35% of its total assets in debt securities rated Ba or lower by Moody's
or BB or lower by S&P, comparably rated by another NRSRO or determined
by Mitchell Hutchins or PIMCO to be of comparable quality without
giving at least 30 days' advance notice to shareholders.
(7) purchase securities on margin, except for short-term credit necessary
for clearance of portfolio transactions and except that the Fund may
make margin deposits in connection with its use of financial options
and futures, forward and spot currency contracts, swap transactions and
other financial contracts or derivative instruments.
(8) engage in short sales of securities or maintain a short position,
except that the Fund may (a) sell short "against the box" and (b)
maintain short positions in connection with its use of financial
options and futures, forward and spot currency contracts, swap
transactions and other financial contracts or derivative instruments.
(9) invest in oil, gas or mineral exploration or development programs or
leases, except that investments in securities of issuers that invest in
such programs or leases and investments in asset-backed securities
supported by receivables generated from such programs or leases are not
subject to this prohibition.
(10) purchase securities of other investment companies, except to the
extent permitted by the 1940 Act and except that this limitation does
not apply to securities received or acquired as dividends, through
offers of exchange, or as a result of reorganization, consolidation,
or merger.
HEDGING AND RELATED INCOME STRATEGIES
GENERAL DESCRIPTION OF HEDGING STRATEGIES. As discussed in the Prospectus,
Mitchell Hutchins or 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 a Fund's
portfolio and to enhance income. Mitchell Hutchins or PIMCO also may attempt to
hedge a 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 a Fund's portfolio. Thus, in a short hedge a 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, a
Fund might purchase a put option on a security to hedge against a potential
decline in the value of that security. If the price of the security declined
below the exercise price of the put, the Fund could exercise the put and thus
limit its loss below the exercise price to the premium paid plus transaction
costs. In the alternative, because the value of the put option can be expected
to increase as the value of the underlying
9
<PAGE>
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 a Fund intends to acquire. Thus, in a long
hedge a 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, a 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.
Each 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. A Fund might enter into a long straddle when Mitchell Hutchins or
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. A
Fund might enter into a short straddle when Mitchell Hutchins or PIMCO 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 a 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, a Fund's
ability to use Hedging Instruments will be limited by tax considerations. See
"Taxes."
In addition to the products, strategies and risks described below and in the
Prospectus, Mitchell Hutchins and PIMCO expect to discover additional
opportunities in connection with options, futures contracts and other hedging
techniques. These new opportunities may become available as Mitchell Hutchins
and PIMCO develop new techniques, as regulatory authorities broaden the range
of permitted transactions and as new options, futures contracts or other
techniques are developed. Mitchell Hutchins or PIMCO may utilize these
opportunities to the extent that they are consistent with a Fund's investment
objective and permitted by the Fund's investment limitations and applicable
regulatory authorities. The Funds' 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.
10
<PAGE>
SPECIAL RISKS OF HEDGING STRATEGIES. The use of Hedging Instruments involves
special considerations and risks, as described below. Risks pertaining to
particular Hedging Instruments are described in the sections that follow.
(1) Successful use of most Hedging Instruments depends upon Mitchell
Hutchins' or PIMCO's ability to predict movements of the overall securities
markets, which requires different skills than predicting changes in the prices
of individual securities. While Mitchell Hutchins and PIMCO are 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.
(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 a Fund entered into a
short hedge because Mitchell Hutchins or 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, a 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 a 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 a 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. A 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 a Fund.
COVER FOR HEDGING STRATEGIES. Transactions using Hedging Instruments, other
than purchased options, expose a Fund to an obligation to another party. A 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)
11
<PAGE>
above. Each 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
a 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. Each Fund may purchase put and call options, and write (sell)
covered put and call options, on debt securities in which it is authorized to
invest. 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 enhance income by reason of the premiums paid by the
purchasers of such options. In addition, 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 of the option, minus the premium
received, the Fund would expect to suffer a loss. 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 a 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.
A Fund may effectively terminate its right or obligation under an option by
entering into a closing transaction. For example, a Fund may terminate its
obligation under a call option that it had written by purchasing an identical
call option; this is known as a closing purchase transaction. Conversely, a
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 a Fund to realize profits or limit
losses on an option position prior to its exercise or expiration.
A 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
12
<PAGE>
completion of every exchange-traded option transaction. In contrast, OTC
options are contracts between a Fund and its contra party (usually a securities
dealer or a bank) with no clearing organization guarantee. Thus, when a 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. A Fund
will enter into OTC option transactions only with contra parties that have a
net worth of at least $20 million.
A Fund's ability to establish and close out positions in exchange-listed
options depends on the existence of a liquid market. Each Fund intends to
purchase or write only those exchange-traded options for which there appears to
be a liquid secondary market. However, there can be no assurance that such a
market will exist at any particular time. Closing transactions can be made for
OTC options only by negotiating directly with the contra party, or by a
transaction in the secondary market if any such market exists. Although a 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 a 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 a 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.
A Fund may purchase and write put and call options on indices of debt
securities in much the same manner as the more traditional options discussed
above, except the index options may serve as a hedge against overall
fluctuations in the debt securities market (or market sectors) rather than
anticipated increases or decreases in the value of a particular security.
GUIDELINES FOR OPTIONS. Each 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 purchased 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 indices of debt securities and options on futures contracts)
purchased by the Fund that are held at any time will not exceed 20% of the
Fund's net assets.
FUTURES. Each Fund may purchase and sell interest rate futures contracts and
Low Duration Fund may purchase and sell debt security index futures contracts.
Each Fund also may purchase
13
<PAGE>
put and call options, and write covered put and call options, on the futures
contracts it is allowed to purchase and sell. 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 options
on securities or indices.
Futures strategies also can be used to manage the average duration of a
Fund's portfolio. If Mitchell Hutchins or PIMCO wishes to shorten the average
duration of a Fund, the Fund may sell a futures contract or a call option
thereon, or purchase a put option on that futures contract. If Mitchell
Hutchins or PIMCO wishes to lengthen the average duration of a Fund, the Fund
may buy a futures contract or a call option thereon or sell a put option
thereon.
Each 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. A Fund will engage in this
strategy only when it is more advantageous to the Fund than is purchasing the
futures contract.
No price is paid upon entering into a futures contract. Instead, at the
inception of a futures contract a 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 a Fund at the
termination of the transaction if all contractual obligations have been
satisfied. Under certain circumstances, such as periods of high volatility, a
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 future position varies, a process known as
"marking to market." Variation margin does not involve borrowing, but rather
represents a daily settlement of a Fund's obligations to or from a futures
broker. When a Fund purchases an option on a future, the premium paid plus
transaction costs is all that is at risk. In contrast, when a Fund purchases or
sells a futures contract or writes a 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.
Each Fund intends to enter into futures transactions only on exchanges or
boards of trade where there appears
14
<PAGE>
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 a Fund were unable to liquidate a futures or options position due to the
absence of a liquid secondary market or the imposition of price limits, it
could incur substantial losses. The Fund would continue to be subject to market
risk with respect to the position. In addition, except in the case of purchased
options, the Fund would continue to be required to make daily variation margin
payments and might be required to maintain the position being hedged by the
future or option or to maintain cash or securities in a segregated account.
Certain characteristics of the futures market might increase the risk that
movements in the prices of futures contracts or related options might not
correlate perfectly with movements in the prices of the investments being
hedged. For example, all participants in the futures and related options
markets are subject to daily variation margin calls and might be compelled to
liquidate futures or related options positions whose prices are moving
unfavorably to avoid being subject to further calls. These liquidations could
increase price volatility of the instruments and distort the normal price
relationship between the futures or options and the investments being hedged.
Also, because initial margin deposit requirements in the futures market are
less onerous than margin requirements in the securities markets, there might be
increased participation by speculators in the futures markets. This
participation also might cause temporary price distortions. In addition,
activities of large traders in both the futures and securities markets
involving arbitrage, "program trading" and other investment strategies might
result in temporary price distortions.
GUIDELINES FOR FUTURES AND RELATED OPTIONS. Each 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 indices of debt securities 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.
15
<PAGE>
INTEREST RATE PROTECTION TRANSACTIONS
Each 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 level or goes below a designated floor on
predetermined dates or during a specified time period. Each 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.
Each Fund may enter into interest rate swaps, caps, collars and floors on
either an asset-based or liability-based basis, depending on whether it is
hedging its assets or its liabilities, and will usually enter into interest
rate swaps on a net basis, i.e., the two payment streams are netted out, with
the Fund receiving or paying, as the case may be, only the net amount of the
two payments. Inasmuch as these interest rate protection transactions are
entered into for good faith hedging purposes, and inasmuch as segregated
accounts will be established with respect to such transactions, Mitchell
Hutchins, PIMCO and the Funds believe such obligations do not constitute senior
securities and, accordingly, will not treat them as being subject to a Fund's
borrowing restrictions. The net amount of the excess, if any, of a 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." Each 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.
A Fund will enter into interest rate protection transactions only with banks
and recognized securities dealers believed by Mitchell Hutchins or 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 as agents
utilizing standardized swap documentation. Caps, collars and floors are more
recent innovations for which documentation is less standardized, and
accordingly they are less liquid than swaps.
16
<PAGE>
TRUSTEES AND OFFICERS; PRINCIPAL HOLDERS OF SECURITIES
The trustees and executive officers of the Trust, their ages, business
addresses and principal occupations during the past five years are:
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE POSITION WITH TRUST OTHER DIRECTORSHIPS
- ---------------------- ------------------- --------------------
<S> <C> <C>
Margo N. Alexander**; 49 Trustee and President Mrs. Alexander is president, chief
executive officer and a director of
Mitchell Hutchins (since January
1995) and also an executive vice
president and a director of
PaineWebber. Mrs. Alexander is
president and a director or trustee
of 30 investment companies for
which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
Richard Q. Armstrong; 60 Trustee Mr. Armstrong is chairman and prin-
78 West Brother Drive cipal of RQA Enterprises (manage-
Greenwich, CT 06830 ment consulting firm) (since April
1991 and principal occupation since
March 1995). Mr. Armstrong is also
a director of Hi Lo Automotive,
Inc. He was chairman of the board,
chief executive officer and co-
owner of Adirondack Beverages (pro-
ducer and distributor of soft
drinks and sparkling/still waters)
(October 1993-March 1995). He was a
partner of the New England Consult-
ing Group (management consulting
firm) (December 1992-September
1993). He was managing director of
LMVH U.S. Corporation (U.S. subsid-
iary of the French luxury goods
conglomerate, Luis Vuitton Moet
Hennessey Corporation) (1987-1991)
and chairman of its wine and spir-
its subsidiary, Schieffelin & Som-
erset Company (1987-1991). Mr. Arm-
strong is a director or trustee of
29 investment companies for which
Mitchell Hutchins or PaineWebber
serves as investment adviser.
</TABLE>
17
<PAGE>
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE POSITION WITH TRUST OTHER DIRECTORSHIPS
- ---------------------- ------------------- --------------------
<S> <C> <C>
E. Garrett Bewkes, Jr.**; 69 Trustee and Chairman of Mr. Bewkes is a director of Paine
the Board of Trustees Webber Group Inc. ("PW Group")
(holding company of PaineWebber and
Mitchell Hutchins). Prior to
December 1995, he was a consultant
to PW Group. Prior to 1988, he was
chairman of the board, president
and chief executive officer of
American Bakeries Company. Mr.
Bewkes is also a director of Inter-
state Bakeries Corporation, NaPro
BioTherapeutics, Inc. and a direc-
tor or trustee of 30 investment
companies for which Mitchell
Hutchins or PaineWebber serves as
investment adviser.
Richard R. Burt; 49 Trustee Mr. Burt is chairman of Interna-
1101 Connecticut Avenue, N.W. tional Equity Partners (interna-
Washington, D.C. 20036 tional investments and consulting
firm) (since March 1994) and a
partner of McKinsey & Company (man-
agement consulting firm) (since
1991). He is also a director of
American Publishing Company. He was
the chief negotiator in the Strate-
gic Arms Reduction Talks with the
former Soviet Union (1989-1991) and
the U.S. Ambassador to the Federal
Republic of Germany (1985-1989).
Mr. Burt is a director or trustee
of 29 investment companies for
which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
Mary C. Farrell**; 46 Trustee Ms. Farrell is a managing director,
senior investment strategist and
member of the Investment Policy
Committee of PaineWebber. Ms.
Farrell joined PaineWebber in 1982.
She is a member of the Financial
Women's Association and Women's
Economic Roundtable and is employed
as a regular panelist on Wall
Street Week with Louis Rukeyser.
She also serves on the Board of
Overseers of New
</TABLE>
18
<PAGE>
<TABLE>
<CAPTION>
NAME AND ADDRESS*; AGE POSITION WITH TRUST OTHER DIRECTORSHIPS
- ---------------------- ------------------- --------------------
<S> <C> <C>
York University's Stern School of
Business. Ms. Farrell is a director
or trustee of 29 investment compa-
nies for which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
Meyer Feldberg; 54 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 Institute
of Technology. Dean Feldberg is
also a director of AMSCO Interna-
tional Inc., Federated Department
Stores, Inc., and New World Commu-
nications Group Incorporated and a
director or trustee of 29 invest-
ment companies for which Mitchell
Hutchins or PaineWebber serves as
investment adviser.
George W. Gowen; 66 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 Fryer,
Ross & Gowen. Mr. Gowen is also a
director of Columbia Real Estate
Investments, Inc. and a director or
trustee of 29 investment companies
for which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
Frederic V. Malek; 59 Trustee Mr. Malek is chairman of Thayer Cap-
901 15th Street, N.W. ital Partners (investment bank) and
Suite 300 a co-chairman and director of CB
Washington, D.C. 20005 Commercial Group Inc. (real es-
tate). From January 1992 to Novem-
ber 1992, he was campaign manager
of Bush-Quayle '92. From 1990 to
1992, he was vice chairman and,
from 1989 to 1990, he was president
of Northwest Airlines Inc., NWA
Inc. (holding
</TABLE>
19
<PAGE>
<TABLE>
<CAPTION>
NAME AND ADDRESS*; BUSINESS EXPERIENCE;
AGE POSITION WITH TRUST OTHER DIRECTORSHIPS
- ------------------ ------------------- --------------------
<S> <C> <C>
company of Northwest Airlines Inc.)
and Wings Holdings Inc. (holding
company of NWA Inc.) Prior to 1989,
he was employed by the Marriott
Corporation (hotels, restaurants,
airline catering and contract feed-
ing), where he most recently was an
executive vice president and presi-
dent of Marriott Hotels and Re-
sorts. Mr. Malek is also a director
of American Management Systems,
Inc., Auto- matic Data Processing,
Inc., Avis, Inc., FPL Group, Inc.,
ICF International, Manor Care,
Inc., National Education Corpora-
tion and Northwest Airlines Inc.
Mr. Malek is a director or trustee
of 29 investment companies for
which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
Carl W. Schafer; 60 Trustee Mr. Schafer is president of the At-
P.O. Box 1164 lantic Foundation (charitable foun-
Princeton, NJ 08542 dation supporting mainly oceano-
graphic exploration and research).
He also is a director of Roadway
Express, Inc. (trucking), The
Guardian Group of Mutual Funds,
Evans Systems, Inc. (a motor fuels,
convenience store and diversified
company), Hidden Lake Gold Mines
Ltd. (gold mining), Electronic
Clearing House, Inc. (financial
transactions processing), Wainoco
Oil Corporation and Nutraceutix,
Inc. (biotechnology). Prior to Jan-
uary 1993, he was chairman of the
Investment Advisory Committee of
the Howard Hughes Medical Insti-
tute. Mr. Schafer is a director or
trustee of 29 investment companies
for which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
</TABLE>
20
<PAGE>
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE POSITION WITH TRUST OTHER DIRECTORSHIPS
- ---------------------- ------------------- --------------------
<S> <C> <C>
John R. Torell III; 56 Trustee Mr. Torell is chairman of Torell
767 Fifth Avenue Management, Inc. (financial advi-
Suite 4605 sory firm), chairman of Telesphere
New York, NY 10153 Corporation (electronic provider of
financial information) and a part-
ner of Zilkha & Company (merchant
bank and private investment compa-
ny). He is the former chairman and
chief executive officer of Fortune
Bancorp (1990-1991 and 1990-1994,
respectively). He is the former
chairman, president and chief exec-
utive officer of CalFed, Inc. (sav-
ings association) (1988 to 1989)
and the former president of Manu-
facturers Hanover Corp. (bank)
(prior to 1988). Mr. Torell is also
a director of American Home Prod-
ucts Corp., New Colt Inc. (armament
manufacturer) and Volt Information
Sciences Inc. Mr. Torell is a di-
rector or trustee of 29 investment
companies for which Mitchell
Hutchins or PaineWebber serves as
investment adviser.
Julieanna Berry; 32 Vice President Ms. Berry is a vice president and a
portfolio manager of Mitchell
Hutchins. Ms. Berry is a vice pres-
ident of two investment companies
for which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
Teresa M. Boyle; 37 Vice President Ms. Boyle is a first vice president
and manager--advisory administra-
tion of Mitchell Hutchins. Prior to
November 1993, she was compliance
manager of Hyperion Capital Manage-
ment, Inc., an investment advisory
firm. Prior to April 1993, Ms.
Boyle was a vice president and man-
ager-- legal administration of
Mitchell Hutchins. Ms. Boyle is a
vice president of 30 investment
companies for which Mitchell
Hutchins or PaineWebber serves as
investment adviser.
</TABLE>
21
<PAGE>
<TABLE>
<CAPTION>
NAME AND BUSINESS EXPERIENCE;
ADDRESS*; AGE POSITION WITH TRUST OTHER DIRECTORSHIPS
- -------------- --- ------------------- --------------------
<S> <C> <C>
Karen L. Finkel; 38 Vice President Mrs. Finkel is a first vice presi-
dent and a portfolio manager of
Mitchell Hutchins. Mrs. Finkel is a
vice president of two investment
company for which Mitchell Hutchins
serves as investment adviser.
Ellen R. Harris; 49 Vice President Ms. Harris is a managing director
and a portfolio manager of Mitchell
Hutchins. Ms. Harris is a vice
president of three investment com-
panies for which Mitchell Hutchins
or PaineWebber serves as investment
adviser.
James F. Keegan; 35 Vice President Mr. Keegan is a senior vice presi-
dent and a portfolio manager of
Mitchell Hutchins. Prior to March
1996, he was director of fixed in-
come strategy and research of
Merrion Group, L.P. From 1987 to
1994, he was a vice president of
Bankers Trust Company, where he was
the director of credit research for
the global investment management
group. Mr. Keegan is a vice presi-
dent of two investment companies
for which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
Thomas J. Libassi; 37 Vice President Mr. Libassi is a senior vice presi-
dent and a portfolio manager of
Mitchell Hutchins. Prior to May
1994, he was a vice president of
Keystone Custodian Funds Inc. with
portfolio management responsibili-
ty. Mr. Libassi is a vice president
of four invest- ment companies for
which Mitchell Hutchins serves as
investment adviser.
C. William Maher; 35 Vice President and Mr. Maher is a first vice president
Assistant Treasurer and a senior manager of the mutual
fund finance division of Mitchell
Hutchins. Mr. Maher is a vice pres-
ident and
</TABLE>
22
<PAGE>
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE POSITION WITH TRUST OTHER DIRECTORSHIPS
- ---------------------- ------------------- --------------------
<S> <C> <C>
assistant treasurer of 30 invest-
ment companies for which Mitchell
Hutchins or PaineWebber serves as
investment adviser.
Dennis McCauley; 49 Vice President Mr. McCauley is a managing director
and chief investment officer--fixed
income of Mitchell Hutchins. Prior
to December 1994, he was director
of fixed income investments of IBM
Corporation. Mr. McCauley is a vice
president of 19 investment compa-
nies for which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
Ann E. Moran; 38 Vice President and Ms. Moran is a vice president of
Assistant Treasurer Mitchell Hutchins. Ms. Moran is a
vice president and assistant trea-
surer of 30 investment companies
for which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
Dianne E. O'Donnell; 43 Vice President and Ms. O'Donnell is a senior vice pres-
Secretary ident and deputy general counsel of
Mitchell Hutchins. Ms. O'Donnell is
a vice president and secretary of
30 investment companies for which
Mitchell Hutchins or PaineWebber
serves as investment adviser.
Victoria E. Schonfeld; Vice President Ms. Schonfeld is a managing director
45 and general counsel of Mitchell
Hutchins. Prior to May 1994, she
was a partner in the law firm of
Arnold & Porter. Ms. Schonfeld is a
vice president of 30 investment
companies for which Mitchell
Hutchins or PaineWebber serves as
investment adviser.
</TABLE>
23
<PAGE>
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE POSITION WITH TRUST OTHER DIRECTORSHIPS
- ---------------------- ------------------- --------------------
<S> <C> <C>
Paul H. Schubert; 33 Vice President and Mr. Schubert is a first vice presi-
Assistant Treasurer dent and a senior manager of the
mutual fund finance division of
Mitchell Hutchins. From August 1992
to August 1994, he was a vice pres-
ident at BlackRock Financial Man-
agement, L.P. Prior to August 1992,
he was an audit manager with Ernst
& Young LLP. Mr. Schubert is a vice
president and assistant treasurer
of 30 investment companies for
which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
Nirmal Singh; 39 Vice President Mr. Singh is a first vice president
and a portfolio manager of Mitchell
Hutchins. Prior to September 1993,
he was a member of the portfolio
management team at Merrill Lynch
Asset Management, Inc. Mr. Singh is
a vice president of five investment
companies for which Mitchell
Hutchins or PaineWebber serves as
investment adviser.
Julian F. Sluyters; 35 Vice President and Mr. Sluyters is a senior vice presi-
Treasurer dent and the director of the mutual
fund finance division of Mitchell
Hutchins. Prior to 1991, he was an
audit senior manager with Ernst &
Young LLP. Mr. Sluyters is a vice
president and treasurer of 30 in-
vestment companies for which Mitch-
ell Hutchins or PaineWebber serves
as investment adviser.
Mark A. Tincher; 40 Vice President Mr. Tincher is a managing director
and chief investment officer--U.S.
equity investments of Mitchell
Hutchins. Prior to March 1995, he
was a vice president and directed
the U.S. funds management and eq-
uity research areas of Chase Man-
hattan Private
</TABLE>
24
<PAGE>
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE POSITION WITH TRUST OTHER DIRECTORSHIPS
- ---------------------- ------------------- --------------------
<S> <C> <C>
Bank. Mr. Tincher is a vice presi-
dent of 14 investment companies for
which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
Craig M. Varrelman; 37 Vice President Mr. Varrelman is a first vice presi-
dent and a portfolio manager of
Mitchell Hutchins. Mr. Varrelman is
a vice president of five investment
companies for which Mitchell
Hutchins or PaineWebber serves as
investment adviser.
Keith A. Weller; 34 Vice President and Mr. Weller is a first vice president
Assistant Secretary and associate general counsel of
Mitchell Hutchins. Prior to May
1995, he was an attorney in private
practice. Mr. Weller is a vice
president and assistant secretary
of 29 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.
** Mrs. Alexander, Mr. Bewkes and Ms. Farrell are "interested persons" of the
Trust as defined in the 1940 Act by virtue of their positions with Mitchell
Hutchins, PaineWebber and/or PW Group.
The Trust pays trustees who are not "interested persons" of the Trust $1,000
annually for each series of the Trust and $150 for each board meeting and each
separate meeting of a board committee. The Trust presently has five series and
thus pays each such trustee $5,000 annually, plus any additional amounts due
for board or committee meetings. Certain committee chairs receive additional
compensation aggregating $15,000 annually from all the funds within the
PaineWebber fund complex. Trustees of the Trust who are "interested persons"
receive no compensation from the Trust. All trustees 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 PaineWebber
and Mitchell Hutchins perform substantially all of the services necessary for
the operation of the Trust and the Funds, 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.
25
<PAGE>
The table below includes certain information relating to the compensation of
the Trust's current trustees who held office with the Trust or other
PaineWebber funds during the fiscal year ended November 30, 1995.
COMPENSATION TABLE
<TABLE>
<CAPTION>
TOTAL
COMPENSATION
AGGREGATE FROM THE
COMPENSATION TRUST AND THE
FROM THE TRUST
NAME OF PERSON, POSITION TRUST(degrees) COMPLEX+
- ------------------------ -------------- -------------
<S> <C> <C>
Richard Q. Armstrong, Trustee...................... -- $ 9,000
Richard Burt, Trustee.............................. -- $ 7,750
Meyer Feldberg, Trustee............................ $7,250 $106,375
George W. Gowen, Trustee........................... $7,250 $ 99,750
Frederick V. Malek, Trustee........................ $7,250 $ 99,750
Carl W. Schafer, Trustee........................... -- $118,175
John R. Torell, III, Trustee....................... -- $ 28,125
</TABLE>
- --------
Only independent members of the board of trustees are compensated by the Trust
and identified above; trustees who are "interested persons," as defined by the
1940 Act, do not receive compensation.
(degrees) Represents fees paid to each trustee during the fiscal year ended
November 30, 1995; the Trust does not have a pension or retirement plan.
+ Represents total compensation paid to each trustee during the year ended
December 31, 1995.
BENEFICIAL OWNERSHIP OF GREATER THAN 5% OF FUND SHARES
The following shareholders are shown in the Trust's records as owning more
than 5% of Low Duration Income Fund's shares.
<TABLE>
<CAPTION>
NUMBER AND PERCENTAGE OF
SHARES BENEFICIALLY
OWNED
NAME AND ADDRESS* AS OF JANUARY 31, 1996
- ----------------- ------------------------
<S> <C>
Hilton Hotels Corporation.............................. 9,100,500.000 (7.2%)
Kern County Treasurer.................................. 8,585,131.170 (6.8%)
</TABLE>
- --------
* Each of the shareholders listed may be contacted c/o Mitchell Hutchins Asset
Management Inc., 1285 Avenue of the Americas, New York, NY 10019.
26
<PAGE>
INVESTMENT ADVISORY AND DISTRIBUTION ARRANGEMENTS
INVESTMENT ADVISORY ARRANGEMENTS. Mitchell Hutchins acts as the investment
adviser and administrator of the Fund pursuant to a contract with the Trust
dated April 21, 1988, as supplemented by a separate fee agreement dated March
26, 1993 with respect to Low Duration Income Fund ("Advisory Contract"). Under
the Advisory Contract, the Trust pays Mitchell Hutchins an annual fee,
computed daily and paid monthly, at the rate of 0.50% of each Fund's average
daily net assets. During the fiscal years ended November 30, 1995, November
30, 1994 and November 30, 1993, respectively, the Trust paid (or accrued) to
Mitchell Hutchins investment advisory and administrative fees of $2,784,437,
$3,958,127 and $4,999,240 with respect to U.S. Government Income Fund. During
the fiscal years ended November 30, 1995 and November 30, 1994 and the period
May 3, 1993 (commencement of operations) to November 30, 1993, the Trust paid
(or accrued) to Mitchell Hutchins investment advisory and administrative fees
of $1,839,876, $5,598,491 (of which $400,611 was waived by Mitchell Hutchins)
and $3,519,442 with respect to Low Duration Income Fund.
Under a service agreement pursuant to which PaineWebber provides certain
services to each Fund not otherwise provided by the Fund's transfer agent,
which agreement is reviewed by the Trust's board of trustees annually, during
the fiscal years ended November 30, 1995, November 30, 1994 and November 30,
1993, respectively, PaineWebber earned fees in the approximate amounts of
$154,428, $196,490 and $217,612 for U.S. Government Income Fund. During the
fiscal years ended November 30, 1995 and November 30, 1994 and the period May
3, 1993 (commencement of operations) to November 30, 1993, respectively,
PaineWebber earned fees under the service agreement in the amounts of
$107,999, $139,291 and $71,854 for Low Duration Income Fund.
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 Low Duration Income
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 fiscal year ended November
30, 1995 and the period October 20, 1994 to November 30, 1994, Mitchell
Hutchins paid (or accrued) to PIMCO sub-advisory fees of $919,938 and
$147,540, respectively, pursuant to the Sub-Advisory Contract and a
substantially similar prior contract.
Under the terms of the Advisory Contract, each Fund bears all expenses
incurred in its operation that are not specifically assumed by Mitchell
Hutchins. General expenses of the Trust not readily identifiable as belonging
to a particular series of the Trust are allocated among the series of the
Trust (including the Funds) 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 each 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
27
<PAGE>
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 a 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. For the fiscal
years ended November 30, 1995, November 30, 1994 and November 30, 1993, no
reimbursements were required pursuant to such limitations.
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 a
Fund in connection with the performance of the Contract, except a loss
resulting from willful misfeasance, bad faith or gross negligence on the part
of Mitchell Hutchins in the performance of its duties or from reckless
disregard of its duties and obligations thereunder. 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, Low Duration Income Fund, its
shareholders or Mitchell Hutchins in connection with the Sub-Advisory Contract,
except any liability to any of them 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 with respect to each Fund 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 Trust. The Sub-Advisory Contract terminates
automatically upon its assignment or the termination of the Advisory Contract
and its terminable at any time without penalty by the board of trustees or by
vote of the holders of a majority of Low Duration Income 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
28
<PAGE>
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 29, 1996,
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)............................... $ 5,653.6
Global.......................................................... 2,836.8
Equity/Balanced................................................. 2,922.3
Fixed Income (excluding Money Market)........................... 5,568.1
Taxable Fixed Income.......................................... 3,854.2
Tax-Free Fixed Income......................................... 1,713.9
Money Market Funds.............................................. 22,732.0
</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 mutual funds and other Mitchell Hutchins'
advisory accounts by all Mitchell Hutchins' directors, officers and employees,
establishes procedures for personal investing and restricts certain
transactions. For example, employee accounts generally must be maintained at
PaineWebber, personal trades in most securities require pre-clearance and
short-term trading and participation in initial public offerings generally are
prohibited. In addition, the code of ethics puts restrictions on the timing of
personal investing in relation to trades by PaineWebber mutual funds and other
Mitchell Hutchins advisory clients.
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 Y shares of each Fund under a distribution contract with the Trust dated
July 1, 1991 ("Distribution Contract") that requires Mitchell Hutchins to use
its best efforts, consistent with its other businesses, to sell shares of the
Funds. Class Y shares of the Funds are offered continuously. Under an exclusive
dealer contract between Mitchell Hutchins and PaineWebber dated July 1, 1991
("Exclusive Dealer Contract"), PaineWebber sells each Fund's Class Y shares.
PORTFOLIO TRANSACTIONS
Subject to policies established by the Trust's board of trustees, Mitchell
Hutchins or PIMCO, as applicable, is responsible for the execution of the
Fund's portfolio transactions and the allocation of brokerage transactions. In
executing portfolio transactions, Mitchell Hutchins and PIMCO seek to obtain
the best net results for a Fund, taking into account such factors as the price
(including the applicable brokerage commission or dealer spread), size of
order, difficulty of execution and
29
<PAGE>
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 that time. While Mitchell Hutchins or PIMCO generally seeks reasonably
competitive commission rates, payment of the lowest commission is not
necessarily consistent with obtaining the best net results. During the fiscal
years ended November 30, 1995, November 30, 1994 and November 30, 1993, U.S.
Government Income Fund paid no brokerage commissions. During the fiscal years
ended November 30, 1995 and November 30, 1994 and the period May 3, 1993 to
November 30, 1993, Low Duration Income Fund paid $0, $88,421 and $0,
respectively, in brokerage commissions.
No Fund has any obligation to deal with any broker or group of brokers in the
execution of portfolio transactions. The Funds contemplate 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 are members of a national securities exchange to effect
portfolio transactions for the Funds on such exchange and to retain
compensation in connection with such transactions. Any such transactions will
be effected and related compensation paid in accordance with applicable SEC
regulations. During the fiscal years ended November 30, 1995, November 30, 1994
and November 30, 1993, neither Fund paid any 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. Each
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 a Fund and subject to the review of the
Trust's board of trustees, Mitchell Hutchins or PIMCO may cause the Fund to
purchase and sell portfolio securities through brokers who provide the Fund
with research, analysis, advice and similar services. In return for such
services, the Fund may pay to those brokers a higher commission than may be
charged by other brokers, provided that Mitchell Hutchins or PIMCO determines
in good faith that such commission is reasonable in terms either of that
particular transaction or of the overall responsibility of Mitchell Hutchins to
the Fund and its other clients and that the total commissions paid by the Fund
will be reasonable in relation to the benefits to the Fund over the long term.
During the fiscal year ended November 30, 1995, neither Fund directed portfolio
transactions to brokers chosen because they provided research services.
For purchases or sales with broker-dealer firms which act as principal,
Mitchell Hutchins and PIMCO seek best execution. Although Mitchell Hutchins or
PIMCO may receive certain research or execution services in connection with
these transactions, neither will purchase securities at a higher price or sell
securities at a lower price than would otherwise be paid if no weight was
30
<PAGE>
attributed to the services provided by the executing dealer. Moreover, neither
Mitchell Hutchins nor PIMCO will enter into any explicit soft dollar
arrangements relating to principal transactions or will receive in principal
transactions the types of services which could be purchased for hard dollars.
Mitchell Hutchins and PIMCO may engage in agency transactions in OTC equity and
debt securities in return for research and execution services. These
transactions are entered into only in compliance with procedures ensuring that
the transaction (including commissions) is at least as favorable as it would
have been if effected directly with a market-maker that did not provide
research or execution services. These procedures include Mitchell Hutchins or
PIMCO receiving multiple quotes from dealers before executing the transaction
on an agency basis.
Information and research services furnished by dealers or brokers with or
through which a Fund effects securities transactions may be used by Mitchell
Hutchins or PIMCO in advising other funds or accounts and, conversely, research
services furnished to Mitchell Hutchins or PIMCO by dealers or brokers in
connection with other funds or accounts Mitchell Hutchins advises may be used
by Mitchell Hutchins or PIMCO in advising a Fund. Information and research
received from such brokers or dealers will be in addition to, and not in lieu
of, the services required to be performed by Mitchell Hutchins under the
Advisory Contract or PIMCO under the Sub-Advisory Contract.
Investment decisions for a Fund and other investment accounts managed by
Mitchell Hutchins or 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 a 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 a 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 Funds will not purchase securities that are offered in underwritings in
which Mitchell Hutchins or any of its affiliates is a member of the
underwriting or selling group except pursuant to procedures adopted by the
Trust's board of trustees pursuant to Rule 10f-3 under the 1940 Act. Among
other things, these procedures require that the commission or spread paid in
connection with such a purchase be reasonable and fair, that the purchase be at
not more than the public offering price prior to the end of the first business
day after the date of the public offering and that Mitchell Hutchins or any
affiliate thereof not participate in or benefit from the sale to the Fund.
PORTFOLIO TURNOVER. Each Fund's annual portfolio turnover rate may vary
greatly from year to year, but it will not be a limiting factor when management
deems portfolio changes appropriate. The portfolio turnover rate is calculated
by dividing the lesser of the Fund's annual sales and 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
the securities in the portfolio during the year. During the fiscal years ended
November 30, 1995 and November 30, 1994, respectively, the portfolio turnover
rates were 206% and 358% for U.S. Government Income Fund and 242% and 246% for
Low Duration Income Fund.
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<PAGE>
VALUATION OF SHARES
Each Fund determines the net asset value per share separately for each Class
of shares as of the close of regular trading (currently 4:00 p.m., Eastern
time) on the NYSE on each Business Day, which is defined as each Monday through
Friday when the NYSE is open. Currently the NYSE is closed on the observance of
the following holidays: New Year's Day, Presidents' Day, Good Friday, Memorial
Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
Where market quotations are readily available, portfolio securities are
valued based upon market quotations, provided such quotations adequately
reflect, in the judgment of Mitchell Hutchins or PIMCO, the fair value of the
security. Where such market quotations are not readily available, securities
are valued based upon appraisals received from a pricing service using a
computerized matrix system or based upon appraisals 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 to maturity
unless the Trust's board of trustees determines that this does not represent
fair value. All other securities or assets will be valued at fair value as
determined in good faith by or under the direction of the Trust's board of
trustees.
PERFORMANCE INFORMATION
Each Fund's performance data quoted in advertising and other promotional
materials ("Performance Advertisements") represents past performance and is 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. All dividends and other distributions are assumed to have been
reinvested at net asset value.
Each 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
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<PAGE>
Fund calculates Non-Standardized Return for specified periods of time by
assuming an investment of $1,000 in Fund shares and assuming the reinvestment
of all dividends and other distributions. The rate of return is determined by
subtracting the initial value of the investment from the ending value and by
dividing the remainder by the initial value.
The following table shows performance information for Class Y shares
(formerly Class C shares) of each Fund for the periods indicated. All returns
for periods of more than one year are expressed as an annualized average
return:
<TABLE>
<CAPTION>
U.S. GOVERNMENT LOW DURATION
INCOME FUND INCOME FUND
--------------- ------------
<S> <C> <C>
Fiscal Year Ended November 30, 1995:
Standardized Return*............................. 15.06% 0.83%
Non-Standardized Return.......................... 15.06 0.83
Inception to November 30, 1995:**
Standardized Return*............................. 5.29 0.83
Non-Standardized Return.......................... 5.29 0.83
</TABLE>
- --------
* Class Y shares do not impose an initial or a contingent deferred sales
charge; therefore, Non-Standardized Return is identical to Standardized
Return.
** For U.S. Government Income Fund, the inception date for its Class Y shares
is September 11, 1991; for Low Duration Income Fund, the inception date for
its Class Y shares is October 20, 1995.
YIELD. Yields used in each 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 semi-
annual compounding) of the net asset value per share at the end of the Period.
Yield quotations are calculated according to the following formula:
YIELD = 2[(a-b + 1)/6/-1]
cd
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 net asset value per share on the last day of the Period.
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
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<PAGE>
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. The yield of the Funds' Class Y
shares for the 30-day period ended November 30, 1995 was 6.11% for U.S.
Government Income Fund and 6.24% for Low Duration Income Fund.
OTHER INFORMATION. In Performance Advertisements each Fund may compare its
Standardized Return and/or its Non-Standardized Return with data published by
Lipper Analytical Services, Inc. ("Lipper") for U.S. government funds, 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, Lehman Bond
Index, 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
companies 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, BARRONS,
FORTUNE, THE NEW YORK TIMES, THE CHICAGO TRIBUNE, THE WASHINGTON POST and THE
KIPLINGER LETTERS. Comparisons in Performance Advertisements may be in graphic
form.
Each 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
by being paid in additional Fund shares, any future income or capital
appreciation of the Fund would increase the value, not only of the original
Fund investment, but also of the additional Fund shares received through
reinvestment. As a result, the value of the Fund investment would increase more
quickly than if dividends or other distributions had been paid in cash.
A Fund may also compare its performance with, or may otherwise discuss, the
performance of bank certificates of deposit (CDs) as measured by the CDA
Certificate of Deposit Index and the Bank Rate Monitor National Index and the
averages of yields of CDs of major banks published by Banxquote (R) Money
Markets. In comparing a Fund or its performance to CDs or to CD performance,
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
34
<PAGE>
interest rates. Fund shares are not insured or guaranteed by the U.S.
government and returns thereon and net asset value will fluctuate. The
securities held by the Fund generally have longer maturities than most CDs and
may reflect interest rate fluctuations for longer term securities. An
investment in the Fund involves greater risks than an investment in either a
money market fund or a CD.
TAXES
In order to continue to qualify for treatment as a regulated investment
company ("RIC") under the Internal Revenue Code, each 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. These requirements include the following: (1) the Fund
must derive at least 90% of its gross income each taxable year from dividends,
interest, payments with respect to securities loans and gains from the sale or
other disposition of securities, or 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 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 that are
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 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 a Fund in November or December
of any year and payable to shareholders of record on a date in either 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 (other than shareholders who are not subject to tax on
their income generally) for the year in which that December 31 falls.
Each Fund invests exclusively in debt securities and receives no dividend
income. Accordingly, no portion of the dividends or capital gain distributions
paid by the Funds are eligible for the dividends-received deduction otherwise
available to corporations that are INSIGHT participants.
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.
Each Fund will be subject to a nondeductible 4% excise tax ("Excise Tax") to
the extent it fails to distribute by the end of any calendar year substantially
all of its ordinary income for that year and capital gain net income for the
one-year period ending on November 30 of that year, plus certain other amounts.
35
<PAGE>
The use of hedging and option income strategies, such as writing (selling)
and purchasing options and futures, involves complex rules that will determine
for income tax purposes the character and timing of recognition of the gains
and losses a Fund realizes in connection therewith. Gains from options and
futures derived by a 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 will be subject to
the Short-Short Limitation if they are held for less than three months.
If a 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. Each Fund
will consider whether it should seek to qualify for this treatment for its
hedging transactions. To the extent a Fund does not qualify for this treatment,
it may be forced to defer the closing out of certain options and futures beyond
the time when it otherwise would be advantageous to do so, in order for the
Fund to continue to qualify as a RIC.
Each Fund may acquire zero coupon or other securities issued with original
issue discount ("OID"). As a holder of such securities, a 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 them during
the year. Each Fund has elected similar treatment with respect to securities
purchased at a discount from their face value ("market discount"). Because each
Fund annually must distribute substantially all of its investment company
taxable income, including any accrued OID and market discount, to satisfy the
Distribution Requirement and avoid imposition of the 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 its 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 October 20, 1995, the name of
Low Duration Income Fund was "PaineWebber Short-Term U.S. Government Income
Fund." Prior to November 10, 1995, each Fund's Class Y shares were called
"Class C" shares.
The Trust is an entity of the type commonly known as a "Massachusetts
business trust." Prior to February 26, 1992, the Trust's name was PaineWebber
Fixed Income Portfolios. Under Massachusetts law, shareholders could, under
certain circumstances, be held personally liable for
36
<PAGE>
the obligations of the Trust or a Fund. However, the Trust's Declaration of
Trust disclaims shareholder liability for acts or obligations of the Trust or
the Funds 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, a Fund,
the trustees or any of them in connection with the Trust. The Declaration of
Trust provides for indemnification from each 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 a 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
each Fund in such a way as to avoid, as far as possible, ultimate liability of
the shareholders for liabilities of the Fund.
COUNSEL. The law firm of Kirkpatrick & Lockhart LLP, 1800 Massachusetts
Avenue, NW, Washington, DC 20036-1800, counsel to the Funds, has passed upon
the legality of the shares offered by the Funds' Prospectus. Kirkpatrick &
Lockhart LLP also acts as counsel to Mitchell Hutchins and PaineWebber in
connection with other matters.
INDEPENDENT AUDITORS. Ernst & Young LLP, 787 Seventh Avenue, New York, New
York 10019, serves as independent auditors for the Trust.
FINANCIAL STATEMENTS
The Funds' Annual Reports to Shareholders for the fiscal year ended November
30, 1995 are separate documents supplied with this Statement of Additional
Information and the financial statements, accompanying notes and reports of
independent auditors appearing therein relating to the Funds are incorporated
by reference in this Statement of Additional Information.
37
<PAGE>
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS NOT CONTAINED IN THE PROSPECTUS OR IN THIS STATEMENT OF
ADDITIONAL INFORMATION IN CONNECTION WITH THE OFFERING MADE BY THE PROSPECTUS
AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED
UPON AS HAVING BEEN AUTHORIZED BY THE FUNDS OR THEIR DISTRIBUTOR. THE
PROSPECTUS AND THIS STATEMENT OF ADDITIONAL INFORMATION DO NOT CONSTITUTE AN
OFFERING BY THE FUNDS OR BY THE DISTRIBUTOR IN ANY JURISDICTION IN WHICH SUCH
OFFERING MAY NOT LAWFULLY BE MADE.
-----------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Policies and Restrictions....................................... 1
Hedging and Related Income Strategies...................................... 9
Trustees and Officers; Principal Holders of Securities..................... 17
Investment Advisory and Distribution Arrangements.......................... 27
Portfolio Transactions..................................................... 29
Valuation of Shares........................................................ 32
Performance Information.................................................... 32
Taxes...................................................................... 35
Other Information.......................................................... 36
Financial Statements....................................................... 37
</TABLE>
RECYCLED PAPER
(C)1996 PAINEWEBBER INCORPORATED
PaineWebber
U.S. Government
Income Fund
Low Duration
U.S. Government
Income Fund
Class Y Shares
- --------------------------------------------------------------------------------
Statement of Additional Information April 1, 1996, as revised May 3, 1996
- --------------------------------------------------------------------------------
