<PAGE>
PAINEWEBBER U.S. GOVERNMENT INCOME FUND
PAINEWEBBER LOW DURATION U.S. GOVERNMENT INCOME FUND
PAINEWEBBER INVESTMENT GRADE INCOME FUND
PAINEWEBBER HIGH INCOME FUND
PAINEWEBBER STRATEGIC INCOME FUND
1285 AVENUE OF THE AMERICAS
NEW YORK, NEW YORK 10019
STATEMENT OF ADDITIONAL INFORMATION
The five funds named above (each a "Fund" and, collectively, "Funds") are
series of professionally managed, open-end management investment companies,
each organized as a Massachusetts business trust. Each Fund seeks generally to
obtain the highest level of income that is consistent with its investment
strategy. PaineWebber Strategic Income Fund ("Strategic Income Fund"), a non-
diversified series of PaineWebber Securities Trust ("Securities Trust" or
"Trust"), strategically allocates its investments among three bond market
sectors: U.S. government and investment grade corporate bonds; U.S. high
yield, high risk corporate bonds; and foreign and emerging market bonds. The
remaining four Funds are diversified series of PaineWebber Managed Investments
Trust ("Managed Investments Trust" or "Trust"). PaineWebber U.S. Government
Income Fund ("U.S. Government Income Fund") invests primarily in U.S.
government bonds, especially those backed by mortgages or other assets.
PaineWebber Low Duration U.S. Government Income Fund ("Low Duration Income
Fund") also invests primarily in U.S. government bonds, especially those
backed by mortgages or other assets, but it limits the expected life
(duration) of its portfolio to from 1 to 3 years. PaineWebber Investment Grade
Income Fund ("Investment Grade Income Fund") invests primarily in a
diversified range of investment grade bonds, including U.S. government and
U.S. and foreign corporate bonds. PaineWebber High Income Fund ("High Income
Fund") invests primarily in a diversified range of high yield, high risk, U.S.
and foreign corporate bonds.
Mitchell Hutchins Asset Management Inc. ("Mitchell Hutchins"), a wholly
owned subsidiary of PaineWebber Incorporated ("PaineWebber"), serves as
investment adviser, administrator and distributor for each Fund. As
distributor, Mitchell Hutchins has appointed PaineWebber as the 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 relates
only to the Funds' Class A, B and C shares. It should be read only in
conjunction with the Funds' current Prospectus for those shares, dated April
1, 1997. 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, 1997.
<PAGE>
INVESTMENT POLICIES AND RESTRICTIONS
The following supplements the information contained in the Prospectus
concerning the investment policies and limitations of the Funds. Except as
otherwise indicated in the Prospectus or the Statement of Additional
Information, there are no policy limitations on a Fund's ability to use the
investments or techniques discussed in these documents.
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 debt obligations. A
description of the ratings assigned to debt obligations by S&P and Moody's is
included in the Appendix 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.
Debt securities rated Ba or lower by Moody's, BB or lower by S&P, comparably
rated by another NRSRO or determined by Mitchell Hutchins to be of comparable
quality are below investment grade, are deemed by those agencies to be
predominantly speculative with respect to
2
<PAGE>
the issuer's capacity to pay interest and repay principal and may involve major
risk exposure to adverse conditions. Lower rated debt securities generally
offer a higher current yield than that available for investment grade issues,
but they involve higher risks, in that they especially subject to adverse
changes in general economic conditions and in the industries in which the
issuers are engaged, to changes in the financial condition of the issuers and
to price fluctuations in response to changes in interest rates. During periods
of economic downturn or rising interest rates, highly leveraged issuers may
experience financial stress which could adversely affect their ability to make
payments of interest and principal and increase the possibility of default. In
addition, such issuers may not have more traditional methods of financing
available to them and may be unable to repay debt at maturity by refinancing.
The risk of loss due to default by such issuers is significantly greater
because such securities frequently are unsecured and subordinated to the prior
payment of senior indebtedness.
The market for lower rated debt securities has expanded rapidly in recent
years, and its growth generally paralleled a long economic expansion. In the
past, the prices of many lower rated debt securities declined substantially,
reflecting an expectation that many issuers of such securities might experience
financial difficulties. As a result, the yields on lower rated debt securities
rose dramatically. However, such higher yields did not reflect the value of the
income stream that holders of such securities expected, but rather the risk
that holders of such securities could lose a substantial portion of their value
as a result of the issuers' financial restructuring or defaults. There can be
no assurance that such declines will not recur. The market for lower rated debt
issues generally is thinner or less active than that for higher quality
securities, which may limit a Fund's ability to sell such securities at fair
value in response to changes in the economy or financial markets. Adverse
publicity and investor perceptions, whether or not based on fundamental
analysis, may also decrease the values and liquidity of lower rated securities,
especially in a thinly traded market.
ASSET-BACKED SECURITIES. Asset-backed securities have structural
characteristics similar to mortgage-backed securities, as discussed in more
detail below. However, the underlying assets are not first lien mortgage loans
or interests therein, but include assets such as motor vehicle installment sale
contracts, other installment sale contracts, home equity loans, leases of
various types of real and personal property and receivables from revolving
credit (credit card) agreements. Such assets are securitized through the use of
trusts or special purpose corporations. Payments or distributions of principal
and interest may be guaranteed up to a certain amount and for a certain time
period by a letter of credit or pool insurance policy issued by a financial
institution unaffiliated with the issuer, or other credit enhancements may be
present.
MORTGAGE-BACKED SECURITIES. Mortgage-backed securities represent direct or
indirect participations in, or are secured by and payable from, mortgage loans
secured by real property and include single- and multi-class pass-through
securities and collateralized mortgage obligations. Multi-class pass-through
securities and collateralized mortgage obligations are collectively referred to
herein as CMOs. The U.S. government mortgage-backed securities in which the
Funds may invest include mortgage-backed securities issued or guaranteed as to
the payment of principal and interest (but not as to market value) by the
Government National Mortgage Association ("Ginnie Mae"), Fannie Mae (formerly,
the Federal National Mortgage Association) or the Federal Home Loan Mortgage
Corporation ("Freddie Mac"). Other mortgage-backed securities are issued by
private issuers, generally originators of and investors in mortgage loans,
including savings
3
<PAGE>
associations, mortgage bankers, commercial banks, investment bankers and
special purpose entities (collectively "Private Mortgage Lenders"). Payments of
principal and interest (but not the market value) of such private mortgage-
backed securities may be supported by pools of mortgage loans or other
mortgage-backed securities that are guaranteed, directly or indirectly, by the
U.S. government or one of its agencies or instrumentalities, or they may be
issued without any government guarantee of the underlying mortgage assets but
with some form of non-government credit enhancement. New types of mortgage-
backed securities are developed and marketed from time to time and, consistent
with its investment limitations, the Funds expect to invest in those new types
of mortgage-backed securities that Mitchell Hutchins or PIMCO believes may
assist a Fund in achieving its investment objective. Similarly, a Fund may
invest in mortgage-backed securities issued by new or existing governmental or
private issuers other than those identified herein.
Ginnie Mae Certificates. Ginnie Mae guarantees certain mortgage pass-through
certificates ("Ginnie Mae certificates") that are issued by Private Mortgage
Lenders and that represent ownership interests in individual pools of
residential mortgage loans. These securities are designed to provide monthly
payments of interest and principal to the investor. Timely payment of interest
and principal is backed by the full faith and credit of the U.S. government.
Each mortgagor's monthly payments to his lending institution on his residential
mortgage are "passed through" to certificateholders such as the Funds. Mortgage
pools consist of whole mortgage loans or participations in loans. The terms and
characteristics of the mortgage instruments are generally uniform within a pool
but may vary among pools. Lending institutions that originate mortgages for the
pools are subject to certain standards, including credit and other underwriting
criteria for individual mortgages included in the pools.
Fannie Mae Certificates. Fannie Mae facilitates a national secondary market
in residential mortgage loans insured or guaranteed by U.S. government agencies
and in privately insured or uninsured residential mortgage loans (sometimes
referred to as "conventional mortgage loans" or "conventional loans") through
its mortgage purchase and mortgage-backed securities sales activities. Fannie
Mae issues guaranteed mortgage pass-through certificates ("Fannie Mae
certificates"), which represent pro rata shares of all interest and principal
payments made and owed on the underlying pools. Fannie Mae guarantees timely
payment of interest and principal on Fannie Mae certificates. The Fannie Mae
guarantee is not backed by the full faith and credit of the U.S. government.
Freddie Mac Certificates. Freddie Mac also facilitates a national secondary
market for conventional residential and U.S. government-insured mortgage loans
through its mortgage purchase and mortgage-backed securities sales activities.
Freddie Mac issues two types of mortgage pass-through securities: mortgage
participation certificates ("PCs") and guaranteed mortgage certificates
("GMCs"). Each PC represents a pro rata share of all interest and principal
payments made and owed on the underlying pool. Freddie Mac generally guarantees
timely monthly payment of interest on PCs and the ultimate payment of
principal, but it also has a PC program under which it guarantees timely
payment of both principal and interest. GMCs also represent a pro rata interest
in a pool of mortgages. These instruments, however, pay interest semi-annually
and return principal once a year in guaranteed minimum payments. The Freddie
Mac guarantee is not backed by the full faith and credit of the U.S.
government.
4
<PAGE>
Private, RTC and Similar Mortgage-Backed Securities. Mortgage-backed
securities issued by Private Mortgage Lenders are structured similarly to the
pass-through certificates and collateralized mortgage obligations ("CMOs")
issued or guaranteed by Ginnie Mae, Fannie Mae and Freddie Mac. Such mortgage-
backed securities may be supported by pools of U.S. government or agency
insured or guaranteed mortgage loans or by other mortgage-backed securities
issued by a government agency or instrumentality, but they generally are
supported by pools of conventional (i.e., non-government guaranteed or insured)
mortgage loans. Since such mortgage-backed securities normally are not
guaranteed by an entity having the credit standing of Ginnie Mae, Fannie Mae
and Freddie Mac, they normally are structured with one or more types of credit
enhancement. See "--Types of Credit Enhancement." These credit enhancements do
not protect investors from changes in market value.
The Resolution Trust Corporation ("RTC"), which was organized by the U.S.
government in connection with the savings and loan crisis, held assets of
failed savings associations as either a conservator or receiver for such
associations, or it acquired such assets in its corporate capacity. These
assets included, among other things, single family and multifamily mortgage
loans, as well as commercial mortgage loans. In order to dispose of such assets
in an orderly manner, RTC established a vehicle registered with the Securities
and Exchange Commission ("SEC") through which it sold mortgage-backed
securities. RTC mortgage-backed securities represent pro rata interests in
pools of mortgage loans that RTC held or acquired, as described above, and are
supported by one or more of the types of private credit enhancements used by
Private Mortgage Lenders.
Collateralized Mortgage Obligations and Multi-Class Mortgage Pass-
Throughs. CMOs are debt obligations that are collateralized by mortgage loans
or mortgage pass-through securities (such collateral collectively being called
"Mortgage Assets"). CMOs may be issued by Private Mortgage Lenders or by
government entities such as Fannie Mae or Freddie Mac. Multi-class mortgage
pass-through securities are interests in trusts that are comprised of Mortgage
Assets and that have multiple classes similar to those in CMOs. Unless the
context indicates otherwise, references herein to CMOs include multi-class
mortgage pass-through securities. Payments of principal of, and interest on,
the Mortgage Assets (and in the case of CMOs, any reinvestment income thereon)
provide the funds to pay debt service on the CMOs or to make scheduled
distributions on the multi-class mortgage pass-through securities.
In a CMO, a series of bonds or certificates is issued in multiple classes.
Each class of CMO, also referred to as a "tranche," is issued at a specific
fixed or floating coupon rate and has a stated maturity or final distribution
date. Principal prepayments on the Mortgage Assets may cause CMOs to be retired
substantially earlier than their stated maturities or final distribution dates.
Interest is paid or accrues on all classes of a CMO (other than any PO class)
on a monthly, quarterly or semi-annual basis. The principal and interest on the
Mortgage Assets may be allocated among the several classes of a CMO in many
ways. In one structure, payments of principal, including any principal
prepayments, on the Mortgage Assets are applied to the classes of a CMO in the
order of their respective stated maturities or final distribution dates so that
no payment of principal will be made on any class of the CMO until all other
classes having an earlier stated maturity or final distribution date have been
paid in full. In some CMO structures, all or a portion of the interest
attributable to one or more of the CMO classes may be added to the principal
amounts attributable to such classes,
5
<PAGE>
rather than passed through to certificateholders on a current basis, until
other classes of the CMO are paid in full.
Parallel pay CMOs are structured to provide payments of principal on each
payment date to more than one class. These simultaneous payments are taken into
account in calculating the stated maturity date or final distribution date of
each class, which, as with other CMO structures, must be retired by its stated
maturity date or final distribution date but may be retired earlier.
Some CMO classes are structured to pay interest at rates that are adjusted in
accordance with a formula, such as a multiple or fraction of the change in a
specified interest rate index, so as to pay at a rate that will be attractive
in certain interest rate environments but not in others. For example, an
inverse floating rate CMO class pays interest at a rate that increases as a
specified interest rate index decreases but decreases as that index increases.
For other CMO classes, the yield may move in the same direction as market
interest rates--i.e., the yield may increase as rates increase and decrease as
rates decrease--but may do so more rapidly or to a greater degree. The market
value of such securities generally is more volatile than that of a fixed rate
obligation. Such interest rate formulas may be combined with other CMO
characteristics. For example, a CMO class may be an "inverse IO," on which the
holders are entitled to receive no payments of principal and are entitled to
receive interest at a rate that will vary inversely with a specified index or a
multiple thereof. Low Duration Income Fund may not invest in inverse floating
rate mortgage- or asset-backed securities. The other Funds are not subject to
any similar limitation.
Types of Credit Enhancement. To lessen the effect of failures by obligors on
Mortgage Assets to make payments, mortgage-backed securities may contain
elements of credit enhancement. Such credit enhancement falls into two
categories: (1) liquidity protection and (2) protection against losses
resulting after default by an obligor on the underlying assets and collection
of all amounts recoverable directly from the obligor and through liquidation of
the collateral. Liquidity protection refers to the provision of advances,
generally by the entity administering the pool of assets (usually the bank,
savings association or mortgage banker that transferred the underlying loans to
the issuer of the security), to ensure that the receipt of payments on the
underlying pool occurs in a timely fashion. Protection against losses resulting
after default and liquidation ensures ultimate payment of the obligations on at
least a portion of the assets in the pool. Such protection may be provided
through guarantees, insurance policies or letters of credit obtained by the
issuer or sponsor, from third parties, through various means of structuring the
transaction or through a combination of such approaches. The Funds will not pay
any additional fees for such credit enhancement, although the existence of
credit enhancement may increase the price of a security. Credit enhancements do
not provide protection against changes in the market value of the security.
Examples of credit enhancement arising out of the structure of the transaction
include "senior-subordinated securities" (multiple class securities with one or
more classes subordinate to other classes as to the payment of principal
thereof and interest thereon, with the result that defaults on the underlying
assets are borne first by the holders of the subordinated class), creation of
"spread accounts" or "reserve funds" (where cash or investments, sometimes
funded from a portion of the payments on the underlying assets, are held in
reserve against future losses) and "over-collateralization" (where the
scheduled payments on, or the principal amount of, the underlying assets exceed
that required to
6
<PAGE>
make payment of the securities and pay any servicing or other fees). The degree
of credit enhancement provided for each issue generally is based on historical
information regarding the level of credit risk associated with the underlying
assets. Delinquency or loss in excess of that anticipated could adversely
affect the return on an investment in such a security.
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, 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
7
<PAGE>
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.
Additional Information on ARM and Floating Rate Mortgage-Backed
Securities. Adjustable rate mortgage ("ARM") securities are mortgage-backed
securities that represent a right to receive interest payments at a rate that
is adjusted to reflect the interest earned on a pool of mortgage loans bearing
variable or adjustable rates of interest (such mortgage loans are referred to
as "ARMs"). 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.
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 specify 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 specify for limitations on the
maximum amount by which the mortgage interest rate may adjust for any single
adjustment period. ARMs also may limit 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.
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.
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
8
<PAGE>
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.
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 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 fixed income 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
9
<PAGE>
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.
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 a Fund is called for redemption,
a 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. 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. The other Funds that may invest in
convertible securities may hold any equity securities they acquire upon
conversion subject only to their limitations on holding equity securities.
DURATION. Duration is a measure of the expected life of a fixed income
security that was developed as a more precise alternative to the concept "term
to maturity." Traditionally, a debt security's "term to maturity" has been used
as a proxy for the sensitivity of the security's price to changes in interest
rates (which is the "interest rate risk" or "volatility" of the security).
However, "term to maturity" measures only the time until a debt security
provides for a final payment, taking no account of the pattern of the
security's payments prior to maturity.
For any fixed income security with interest payments occurring prior to the
payment of principal, duration is always less than maturity. For example,
depending upon its coupon and the level of market yields, a Treasury note with
a remaining maturity of five years might have a duration of 4.5 years. For
mortgage-backed and other securities that are subject to prepayments, put or
call features or adjustable coupons, the difference between the remaining
stated maturity and the duration is likely to be much greater.
Futures, options and options on futures have durations that, in general, are
closely related to the duration of the securities that underlie them. Holding
long futures or call option positions (backed by a segregated account of cash
and cash equivalents) will lengthen a Fund's duration by approximately the same
amount as would holding an equivalent amount of the underlying securities.
Short futures or put options have durations roughly equal to the negative
duration of the securities that underlie these positions, and have the effect
of reducing portfolio duration by approximately the same amount as would
selling an equivalent amount of the underlying securities.
There are some situations in which the standard duration calculation does not
properly reflect the interest rate exposure of a security. For example,
floating and variable rate securities often have final maturities of ten or
more years; however, their interest rate exposure corresponds to the frequency
of the coupon reset. Another example where the interest rate exposure is not
properly captured by the standard duration calculation is the case of mortgage-
backed securities. The stated final maturity of such securities is generally 30
years, but current prepayment rates are critical in determining the securities'
interest rate exposure. In these and other similar situations, Mitchell
Hutchins and PIMCO will use more sophisticated analytical techniques that
incorporate the economic life of a security into the determination of its
duration and, therefore, its interest rate exposure.
ILLIQUID SECURITIES. Each Fund may invest up to 10% of its net assets (15%
for Low Duration Income Fund and Strategic Income Fund) in illiquid securities.
The term "illiquid securities" for
10
<PAGE>
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 a Trust's board of
trustees (sometimes referred to as a "board"). 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.
Under current SEC guidelines, interest only ("IO") and principal only ("PO")
classes of mortgage-backed securities are considered illiquid. However, IO and
PO classes of fixed-rate mortgage-backed securities issued by the U.S.
government or one of its agencies or instrumentalities will not be considered
illiquid if Mitchell Hutchins or PIMCO has determined that they are liquid
pursuant to guidelines established by each Trust's board.
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"). A Fund
may not be able to sell illiquid securities when Mitchell Hutchins or PIMCO
considers it desirable to do so or may have to sell such securities at a price
lower than could be obtained if they were liquid. Also the sale of illiquid
securities may require more time and may result in higher dealer discounts and
other selling expenses than does the sale of securities that are not illiquid.
Illiquid securities may be difficult to value due to the unavailability of
reliable market quotations for such securities. 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,
11
<PAGE>
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.
Each Trust's board 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.
ZERO COUPON, OID AND PIK SECURITIES. Federal tax law requires that a holder
of a security with original issue discount ("OID") accrue a portion of the OID
on the security as income each year, even though the holder may receive no
interest payment on the security during the year. Accordingly, although the
investing Fund will receive no payments on its zero coupon securities prior to
their maturity or disposition, it will have income attributable to such
securities. Similarly, while payment-in-kind ("PIK") securities may pay
interest in the form of additional securities rather than cash, that interest
must be included in a Fund's annual income.
To qualify for pass-through federal income tax treatment as regulated
investment companies, the Funds must distribute substantially all of their net
investment income each year, including non-cash income. Accordingly, each Fund
will be required to include in its dividends an amount equal to the income
attributable to its zero coupon, other OID and PIK securities. See "Taxes."
Those dividends will be paid from the cash assets of a Fund or by liquidation
of portfolio securities, if necessary, at a time when the Fund otherwise might
not have done so.
Certain zero coupon securities are U.S. Treasury notes and bonds that have
been stripped of their unmatured interest coupon receipts or interests in such
U.S. Treasury securities or coupons. The staff of the SEC currently takes the
position that "stripped" U.S. government securities that are not issued through
the U.S. Treasury are not U.S. government securities. This technique is
frequently used with U.S. Treasury bonds to create CATS (Certificate of Accrual
Treasury Securities), TIGRs (Treasury Income Growth Receipts) and similar
securities. As long as the SEC takes this position, CATS and TIGRs, which are
not issued through the U.S. Treasury, will not be counted as U.S. government
securities for purposes of the 65% investment requirement applicable to U.S.
Government Income Fund and Low Duration Income Fund.
MONEY MARKET INSTRUMENTS. Each Fund may hold up to 35% (100% for Strategic
Income Fund) of its total assets in cash or money market instruments for
liquidity purposes or pending investment. In addition, when Mitchell Hutchins
or PIMCO believes unusual circumstances warrant a defensive position, each Fund
temporarily may commit all or any portion of its assets to cash, including cash
denominated in foreign currencies (Strategic Income Fund), or money market
instruments, including instruments of foreign issuers (Strategic Income Fund).
Money market instruments may include securities issued or guaranteed by the
U.S. government, its agencies or
12
<PAGE>
instrumentalities, commercial paper rated at least A-1 by S&P or P-1 by Moody's
(Low Duration Income Fund and Investment Grade Income Fund) or without regard
to rating (High Income Fund and Strategic Income Fund), bank certificates of
deposit, bankers' acceptances and repurchase agreement secured by any of the
foregoing. The money market instruments of U.S. Government Income Fund will be
limited to obligations of the U.S. government, its agencies or
instrumentalities and repurchase agreements secured by such obligations.
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 or upon demand and at a 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 or upon demand 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 each Trust's board. Mitchell Hutchins reviews and
monitors the creditworthiness of those institutions under the board's general
supervision.
REVERSE REPURCHASE AGREEMENTS. Each Fund 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 or upon demand and at a 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. 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,
13
<PAGE>
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. Strategic Income Fund may invest without limit in
securities denominated in 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. 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. 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 SEC, nor the issuers thereof subject to its reporting requirements.
Accordingly, there may be less publicly available information 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 a Fund's 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 a Fund's 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 a Fund's
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 or
Strategic Income Fund frequently are higher than those attributable to domestic
investing; this is particularly true with respect to emerging capital markets.
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 may be subject to foreign withholding or other
government taxes that could reduce the return of these securities. Tax treaties
14
<PAGE>
between the United States and foreign countries, however, may reduce or
eliminate the amount of foreign tax to which the Funds would be subject.
All or a substantial portion of High Income Fund's or Strategic Income Fund's
investments in foreign and emerging market securities may be rated below
investment grade or may be unrated securities with credit characteristics that
are comparable to securities that are rated below investment grade. Strategic
Income Fund may invest without limit in securities of issuers in emerging
market countries and in non-U.S. dollar-denominated fixed income securities,
including securities denominated in the local currencies of emerging market
countries.
SPECIAL CHARACTERISTICS OF FOREIGN AND EMERGING MARKET SECURITIES
EMERGING MARKET SECURITIES. Many foreign and emerging market securities are
not registered with the SEC, nor are the issuers thereof subject to SEC
reporting requirements. Accordingly, there may be less publicly available
information concerning foreign issuers of securities held by a Fund than is
available concerning U.S. companies. Disclosure and regulatory standards in
many respects are less stringent in emerging market countries than in the U.S.
and other major markets. There also may be a lower level of monitoring and
regulation of emerging markets and the activities of investors in such markets,
and enforcement of existing regulations may be extremely limited. Foreign
companies and, in particular, companies in smaller and emerging capital markets
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. A Fund's net investment income and capital gains
from its foreign investment activities may be subject to non-U.S. withholding
taxes.
Foreign markets also have different clearance and settlement procedures, and
in certain markets there have been times when settlements have failed to keep
pace with the volume of securities transactions, making it difficult to conduct
such transactions. Delays in settlement could result in the temporary periods
when assets of a Fund are uninvested and no return is earned thereon. The
inability of a Fund to make intended security purchases due to settlement
problems could cause the Fund to miss attractive investment opportunities.
Inability to dispose of a portfolio security due to settlement problems could
result either in losses to the Fund due to subsequent declines in the value of
such portfolio security or, if the Fund has entered into a contract to sell the
security, could result in possible liability to the purchaser.
SOVEREIGN DEBT. Sovereign debt differs from debt obligations issued by
private entities in that, generally, remedies for defaults must be pursued in
the courts of the defaulting party. Legal recourse is, therefore, limited.
Political conditions, especially a sovereign entity's willingness to meet the
terms of its debt obligations, are of considerable significance. Also, there
can be no assurance that the holders of commercial bank loans to the same
sovereign entity may not contest payments to the holders of sovereign debt in
the event of default under commercial bank loan agreements.
A sovereign debtor's willingness or ability to pay interest and repay
principal in a timely manner may be affected by, among other factors, its cash
flow situation, the extent of its foreign reserves, the availability of
sufficient foreign exchange on the date a payment is due, the relative size of
the debt service burden to the economy as a whole, the sovereign debtor's
policy toward principal international lenders and the political constraints to
which a sovereign debtor may be
15
<PAGE>
subject. A country whose exports are concentrated in a few commodities could be
vulnerable to a decline in the international price of such commodities.
Increased protectionism on the part of a country's trading partners, or
political changes in those countries, could also adversely affect its exports.
Such events could diminish a country's trade account surplus, if any, or the
credit standing of a particular local government or agency. Another factor
bearing on the ability of a country to repay sovereign debt is the level of the
country's international reserves. Fluctuations in the level of these reserves
can affect the amount of foreign exchange readily available for external debt
payments and, thus, could have a bearing on the capacity of the country to make
payments on its sovereign debt.
To the extent that a country has a current account deficit (generally when
exports of merchandise and services are less than the country's imports of
merchandise and services plus net transfers (e.g., gifts of currency and goods)
to foreigners), it will need to depend on loans from foreign governments,
multilateral organizations or private commercial banks, aid payments from
foreign governments and inflows of foreign investment. The access of a country
to these forms of external funding may not be certain, and a withdrawal of
external funding could adversely affect the capacity of a government to make
payments on its obligations. In addition, the cost of servicing debt
obligations can be affected by a change in international interest rates, since
the majority of these obligations carry interest rates that are adjusted
periodically based upon international rates.
With respect to sovereign debt of emerging market issuers, investors should
be aware that certain emerging market countries are among the largest debtors
to commercial banks and foreign governments. At times certain emerging market
countries have declared moratoria on the payment of principal and interest on
external debt; such moratoria are currently in effect in certain Latin American
countries.
Certain emerging market countries have experienced difficulty in servicing
their sovereign debt on a timely basis which led to defaults on certain
obligations and the restructuring of certain indebtedness. Restructuring
arrangements have included, among other things, reducing and rescheduling
interest and principal payments by negotiating new or amended credit agreements
or converting outstanding principal and unpaid interest to Brady Bonds
(discussed below), and obtaining new credit to finance interest payments.
Holders of sovereign debt, including the Funds, may be requested to participate
in the rescheduling of such debt and to extend further loans to sovereign
debtors. The interests of holders of sovereign debt could be adversely affected
in the course of restructuring arrangements or by certain other factors
referred to below. Furthermore, some of the participants in the secondary
market for sovereign debt may also be directly involved in negotiating the
terms of these arrangements and may, therefore, have access to information not
available to other market participants. Obligations arising from past
restructuring agreements may affect the economic performance and political and
social stability of certain issuers of sovereign debt. There is no bankruptcy
proceeding by which sovereign debt on which a sovereign has defaulted may be
collected in whole or in part.
Foreign investment in certain sovereign debt is restricted or controlled to
varying degrees. These restrictions or controls may at times limit or preclude
foreign investment in such sovereign debt and increase the costs and expenses
of a Fund. Certain countries in which a Fund may invest require governmental
approval prior to investments by foreign persons, limit the amount of
16
<PAGE>
investment by foreign persons in a particular issuer, limit the investment by
foreign persons only to a specific class of securities of an issuer that may
have less advantageous rights than the classes available for purchase by
domiciliaries of the countries or impose additional taxes on foreign investors.
Certain issuers may require governmental approval for the repatriation of
investment income, capital or the proceeds of sales of securities by foreign
investors. In addition, if a deterioration occurs in a country's balance of
payments the country could impose temporary restrictions on foreign capital
remittances. A Fund could be adversely affected by delays in, or a refusal to
grant, any required governmental approval for repatriation of capital, as well
as by the application to the Fund of any restrictions on investments. Investing
in local markets may require a Fund to adopt special procedures, seek local
government approvals or take other actions, each of which may involve
additional costs to the Fund.
BRADY BONDS. Brady Bonds are sovereign debt securities issued under the
framework of the Brady Plan, an initiative announced by former U.S. Treasury
Secretary Nicholas F. Brady in 1989 as a mechanism for debtor nations to
restructure their outstanding external commercial bank indebtedness. In
restructuring its external debt under the Brady Plan framework, a debtor nation
negotiates with its existing bank lenders as well as multilateral institutions
such as the IMF. The Brady Plan framework, as it has developed, contemplates
the exchange of commercial bank debt for newly issued Brady Bonds. Brady Bonds
may also be issued in respect of new money being advanced by existing lenders
in connection with the debt restructuring. The World Bank and the IMF support
the restructuring by providing funds pursuant to loan agreements or other
arrangements which enable the debtor nation to collateralize the new Brady
Bonds or to repurchase outstanding bank debt at a discount.
Brady Plan debt restructurings totalling more than $80 billion have been
implemented to date in Mexico, Costa Rica, Venezuela, Uruguay, Nigeria,
Argentina and the Philippines and, in addition, Brazil has announced intentions
to issue Brady Bonds. There can be no assurance that the circumstances
regarding the issuance of Brady Bonds by these countries will not change.
Investors should recognize that Brady Bonds have been issued only recently, and
accordingly do not have a long payment history. Agreements implemented under
the Brady Plan to date are designed to achieve debt and debt-service reduction
through specific options negotiated by a debtor nation with its creditors. As a
result, the financial packages offered by each country differ. The types of
options have included the exchange of outstanding commercial bank debt for
bonds issued at 100% of face value of such debt, which carry a below-market
stated rate of interest (generally known as par bonds), bonds issued at a
discount from the face value of such debt (generally known as discount bonds),
bonds bearing an interest rate which increases over time and bonds issued in
exchange for the advancement of new money by existing lenders. Regardless of
the stated face amount and stated interest rate of the various types of Brady
Bonds, a Fund will purchase Brady Bonds in secondary markets, as described
below, in which the price and yield to the investor reflect market conditions
at the time of purchase.
Certain Brady Bonds have been collateralized as to principal due at maturity
by U.S. Treasury zero coupon bonds with maturities equal to the final maturity
of such Brady Bonds. Collateral purchases are financed by the IMF, the World
Bank and the debtor nations' reserves. In the event of a default with respect
to collateralized Brady Bonds as a result of which the payment obligations of
the issuer are accelerated, the U.S. Treasury zero coupon obligations held as
collateral for the payment of principal will not be distributed to investors,
nor will such obligations be sold and the proceeds distributed. The collateral
will be held by the collateral agent to the scheduled maturity
17
<PAGE>
of the defaulted Brady Bonds, which will continue to be outstanding, at which
time the face amount of the collateral will equal the principal payments which
would have then been due on the Brady Bonds in the normal course. In addition,
interest payments on certain types of Brady Bonds may be collateralized by cash
or high grade securities in amounts that typically represent between 12 and 18
months of interest accruals on these instruments, with the balance of the
interest accruals being uncollateralized. Brady Bonds are often viewed as
having several valuation components: (1) the collateralized repayment of
principal, if any, at final maturity, (2) the collateralized interest payments,
if any, (3) the uncollateralized interest payments and (4) any uncollateralized
repayment of principal at maturity (these uncollateralized amounts constitute
the "residual risk"). In light of the residual risk of Brady Bonds and, among
other factors, the history of defaults with respect to commercial bank loans by
public and private entities of countries issuing Brady Bonds, investments in
Brady Bonds are to be viewed as speculative. A Fund may purchase Brady Bonds
with no or limited collateralization, and will be relying for payment of
interest and (except in the case of principal collateralized Brady Bonds)
repayment of principal primarily on the willingness and ability of the foreign
government to make payment in accordance with the terms of the Brady Bonds.
Brady Bonds issued to date are purchased and sold in secondary markets through
U.S. securities dealers and other financial institutions and are generally
maintained through European transnational securities depositories.
STRUCTURED FOREIGN INVESTMENTS. This term refers to interests in U.S. and
foreign entities organized and operated solely for the purpose of securitizing
or restructuring the investment characteristics of foreign securities. This
type of securitization or restructuring involves the deposit with or purchase
by a U.S. or foreign entity, such as a corporation or trust, of specified
instruments (such as commercial bank loans or Brady Bonds) and the issuance by
that entity of one or more classes of securities backed by, or representing
interests in, the underlying instruments. The cash flow on the underlying
instruments may be apportioned among the newly issued structured foreign
investments to create securities with different investment characteristics such
as varying maturities, payment priorities and interest rate provisions, and the
extent of the payments made with respect to structured foreign investments is
dependent on the extent of the cash flow on the underlying instruments.
Structured foreign investments frequently involve no credit enhancement.
Accordingly, their credit risk generally will be equivalent to that of the
underlying instruments. In addition, classes of structured foreign investments
may be subordinated to the right of payment of another class. Subordinated
structured foreign investments typically have higher yields and present greater
risks that unsubordinated structured foreign investments. Structured foreign
investments are typically sold in private placement transactions, and there
currently is no active trading market for structured foreign investments.
SELECTION OF SECURITIES--STRATEGIC INCOME FUND. In selecting U.S. government
and investment grade securities for Strategic Income Fund's portfolio, Mitchell
Hutchins will consider factors such as the general level of interest rates,
changes in the perceived creditworthiness of the issuers, the prepayment
outlook for the mortgage market and changes in general economic conditions and
business conditions affecting the issuers and their respective industries.
18
<PAGE>
In selecting U.S. high yield securities for Strategic Income Fund's
portfolio, Mitchell Hutchins seeks to identify issuers and industries that
Mitchell Hutchins believes are more likely to experience stable or improving
financial conditions. Many corporations are in the process of strengthening, or
have recently improved, their financial positions through cost-cutting,
restructuring or refinancing with lower cost debt. Mitchell Hutchins expects
that, at times when the U.S. economy is improving, these factors and others may
lead many issuers to experience financial improvement and possible credit
upgrades. Mitchell Hutchins seeks to identify these issuers through detailed
credit research. Mitchell Hutchins' analysis may include consideration of
general industry trends, the issuer's experience and managerial strength,
changing financial conditions, borrowing requirements or debt maturity
schedules, the issuer's responsiveness to changes in business conditions and
interest rates, and other terms and conditions. Mitchell Hutchins may also
consider relative values based on anticipated cash flow, interest or dividend
coverage, asset coverage and earnings prospects.
Mitchell Hutchins selectively invests Strategic Income Fund's assets
allocated to foreign and emerging market securities in securities of issuers in
countries where the combination of income market yields, the price appreciation
potential of fixed income securities and, with respect to non-U.S. dollar-
denominated securities, currency exchange rate movements present opportunities
for high current income and, secondarily, capital appreciation. Determinations
as to the foreign markets in which the Fund invests are based on an evaluation
of total debt levels, currency reserve levels, net exports/imports, overall
economic growth, level of inflation, currency fluctuation, political and social
climate and payment history of the country in which the issuer is located.
Particular securities are selected based upon credit risk analysis of potential
issuers, the characteristics of the security and interest rate sensitivity of
the various issues by a single issuer, analysis of volatility and liquidity of
these particular instruments and the tax implications to the Fund of various
instruments.
LENDING OF PORTFOLIO SECURITIES. As indicated in the Prospectus, each Fund is
authorized to lend up to 33 1/3% of its total assets to broker-dealers or
institutional investors that Mitchell Hutchins deems qualified, but only when
the borrower maintains acceptable collateral with the Fund's custodian in an
amount, marked to market daily, 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 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, when
regaining such rights is considered to be in the Fund's interest.
LOAN PARTICIPATIONS AND ASSIGNMENTS. Investment Grade Income Fund and High
Income Fund each may invest up to 5% of its net assets and Strategic Income
Fund may invest without
19
<PAGE>
limitation 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 or liquid 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 Other Strategies Using
Derivative Contracts," segregated accounts may also be required in connection
with certain transactions involving options or futures contracts, interest rate
protection transactions or forward currency contracts.
FUNDAMENTAL INVESTMENT LIMITATIONS. The following 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
20
<PAGE>
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 following limitations:
Each Fund will not:
(1) 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.
(2) 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.
(3) 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, bankers' acceptances or similar instruments will not be
considered the making of a loan.
(4) 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.
(5) 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.
(6) 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.
In addition, U.S. Government Income Fund, Low Duration Income Fund,
Investment Grade Income Fund and High Income Fund will not:
(7) 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
21
<PAGE>
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.
NON-FUNDAMENTAL LIMITATIONS. The following investment restrictions may be
changed by each board without shareholder approval.
Each Fund will not:
(1) invest more than 10% (15% for Low Duration Income Fund and Strategic
Income Fund) 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.
(2) 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.
(3) 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.
(4) 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.
(5) purchase portfolio securities while borrowings in excess of 5% of its
total assets are outstanding.
HEDGING AND OTHER STRATEGIES USING DERIVATIVE CONTRACTS
GENERAL DESCRIPTION OF DERIVATIVE INSTRUMENTS. As discussed in the
Prospectus, Mitchell Hutchins or PIMCO may use a variety of financial
instruments ("Derivative 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 or
realize gains. 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 and Strategic Income Fund may use forward currency contracts for
hedging purposes. A Fund may enter into transactions using one or more types of
Derivative Instruments under which the full value of its portfolio is at risk.
Under
22
<PAGE>
normal circumstances, however, a Fund's use of these instruments will place at
risk a much smaller portion of its assets. The particular Derivative
Instruments used by the Funds are described below.
OPTIONS ON DEBT SECURITIES AND FOREIGN CURRENCIES. A call option is a short-
term contract pursuant to which the purchaser of the option, in return for a
premium, has the right to buy the security or currency underlying the option
at a specified price at any time during the term of the option. The writer of
the call option, who receives the premium, has the obligation, upon exercise
of the option during the option term, to deliver the underlying security or
currency against payment of the exercise price. A put option is a similar
contract which gives its purchaser, in return for a premium, the right to sell
the underlying security or currency at a specified price during the option
term. The writer of the put option, who receives the premium, has the
obligation, upon exercise of the option during the option term, to buy the
underlying security or currency at the exercise price.
OPTIONS ON INDICES OF DEBT SECURITIES. An index assigns relative values to
the securities included in the index and fluctuates with changes in the market
values of such securities. Index options operate in the same way as more
traditional options, except that exercises of index options are effected with
cash payment and do not involve delivery of securities. Thus, upon exercise of
an index option, the purchaser will realize, and the writer will pay, an
amount based on the difference between the exercise price and the closing
price of the index.
DEBT SECURITY INDEX FUTURES CONTRACTS. A debt security index futures
contract is a bilateral agreement pursuant to which one party agrees to
accept, and the other party agrees to make, delivery of an amount of cash
equal to a specified dollar amount times the difference between the index
value at the close of trading of the contract and the price at which the
futures contract is originally struck. No physical delivery of the securities
comprising the index is made; generally, contracts are closed out prior to the
expiration date of the contract.
INTEREST RATE FUTURES CONTRACTS. An interest rate futures contract is a
bilateral agreement pursuant to which one party agrees to make, and the other
party agrees to accept, delivery of the specified type of debt security called
for in the contract at a specified future time and at a specified price.
Although interest rate futures contracts by their terms call for actual
delivery or acceptance of debt securities, in most cases the contracts are
closed out before the settlement date without the making or taking of
delivery.
OPTIONS ON FUTURES CONTRACTS. Options on futures contracts are similar to
options on securities, except that an option on a futures contract gives the
purchaser the right, in return for the premium paid, to assume a position in a
futures contract (a long position if the option is a call and a short position
if the option is a put), rather than to purchase or sell a security, at a
specified price at any time during the option term. Upon exercise of the
option, the delivery of the futures position to the holder of the option will
be accompanied by delivery of the accumulated balance that represents the
amount by which the market price of the futures contract exceeds, in the case
of a call, or is less than, in the case of a put, the exercise price of the
option on the future. The writer of an option, upon exercise, will assume a
short position in the case of a call and a long position in the case of a put.
FORWARD CURRENCY CONTRACTS. A forward currency contract involves an
obligation to purchase or sell a specific currency at a specified future date,
which may be any fixed number of days from the contract date agreed upon by
the parties, at a price set at the time the contract is entered into.
23
<PAGE>
GENERAL DESCRIPTION OF HEDGING STRATEGIES. Hedging strategies can be broadly
categorized as "short hedges" and "long hedges." A short hedge is a purchase or
sale of a Derivative 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 Derivative 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 Derivative 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 Derivative 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 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 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.
Derivative 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. Derivative Instruments on debt securities may be used to
hedge either individual securities or broad fixed income market sectors.
The use of Derivative Instruments is subject to applicable regulations of the
SEC, the several options and futures exchanges upon which they are traded and
the Commodity Futures Trading Commission ("CFTC"). In addition, a Fund's
ability to use Derivative 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
derivative contracts and hedging techniques. These new opportunities
24
<PAGE>
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 derivative contracts and 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 STRATEGIES USING DERIVATIVE INSTRUMENTS. The use of
Derivative Instruments in hedging strategies involves special considerations
and risks, as described below. Risks pertaining to particular Derivative
Instruments are described in the sections that follow:
(1) Successful use of most Derivative 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 Derivative 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 Derivative Instrument and price movements of the
investments being hedged. For example, if the value of a Derivative 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
Derivative 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 Derivative Instrument. Moreover, if the price of
the Derivative 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 Derivative Instruments involving obligations to third parties
(i.e., Derivative Instruments other than purchased options). If a Fund were
unable to close out its positions in such Derivative 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 Derivative 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 position can be
closed out at a time and price that is favorable to the Fund.
25
<PAGE>
COVER FOR STRATEGIES USING DERIVATIVE INSTRUMENTS. Transactions using
Derivative 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 and Strategic Income Fund) or other options,
futures contracts or (for High Income Fund and Strategic Income Fund) forward
currency contracts or (2) cash and liquid 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 these transactions and will, if the guidelines so require, set aside
cash or liquid 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 Derivative 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 and
Strategic 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
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
26
<PAGE>
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 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 its board 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.
27
<PAGE>
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 and Strategic Income 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's
portfolio, 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 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 with the futures
broker through whom the transaction was effected, "initial margin" consisting
of cash, obligations of the United States or obligations fully guaranteed as to
principal and interest by the United States, 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.
28
<PAGE>
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.
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 its board without shareholder vote:
1. To the extent a Fund enters into futures contracts and options on futures
positions including, for High Income Fund and Strategic 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.
29
<PAGE>
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
and Strategic 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 portfolio securities
are denominated. Such currency hedges can protect against price movements in a
security a 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.
A Fund might seek to hedge against changes in the value of a particular
currency when no Derivative Instruments on that currency are available or such
Derivative Instruments are more expensive than certain other Derivative
Instruments. In such cases, a Fund may hedge against price movements in that
currency by entering into transactions using Derivative 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 Derivative Instrument will
not correlate perfectly with movements in the price of the currency being
hedged is magnified when this strategy is used.
The value of Derivative 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 Derivative
Instruments, a 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 Derivative 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, a 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 and Strategic 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, a Fund may
30
<PAGE>
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, a
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 and Strategic 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, a 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 Derivative Instrument
will not correlate or will correlate unfavorably with the foreign currency
being hedged.
The cost to a 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, a 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
31
<PAGE>
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 and
Strategic 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 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
32
<PAGE>
accordance with guidelines established by each board. 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.
33
<PAGE>
TRUSTEES AND OFFICERS; PRINCIPAL HOLDERS OF SECURITIES
The trustees and executive officers of the Trusts, their ages, business
addresses and principal occupations during the past five years are:
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE POSITION WITH TRUSTS OTHER DIRECTORSHIPS
---------------------- -------------------- --------------------
<S> <C> <C>
Margo N. Alexander**; 50 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 29 investment compa-
nies for which Mitchell
Hutchins or PaineWebber
serves as investment
adviser.
Richard Q. Armstrong; 61 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 LVMH
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
28 investment companies
for which Mitchell
Hutchins or PaineWebber
serves as investment
adviser.
</TABLE>
34
<PAGE>
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE POSITION WITH TRUSTS OTHER DIRECTORSHIPS
---------------------- -------------------- --------------------
<S> <C> <C>
E. Garrett Bewkes, Jr.**; 70 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 29 invest-
ment companies for
which Mitchell Hutchins
or PaineWebber serves
as investment adviser.
Richard R. Burt; 50 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 and Ar-
cher-Daniels-Midland
Co. (agricultural com-
modities). He was the
chief negotiator in the
Strategic Arms Reduc-
tion 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 28 in-
vestment companies for
which Mitchell Hutchins
or PaineWebber serves
as investment adviser.
Mary C. Farrell**; 47 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
$treet 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 28 in-
vestment companies for
which Mitchell Hutchins
or PaineWebber serves
as investment adviser.
</TABLE>
35
<PAGE>
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE POSITION WITH TRUSTS OTHER DIRECTORSHIPS
---------------------- -------------------- --------------------
<S> <C> <C>
Meyer Feldberg; 55 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 K-III Com-
munications Corpora-
tion, Federated Depart-
ment Stores, Inc., and
Revlon, Inc. and a di-
rector or trustee of 28
investment companies
for which Mitchell
Hutchins or PaineWebber
serves as investment
adviser.
George W. Gowen; 67 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 28 invest-
ment companies for
which Mitchell Hutchins
or PaineWebber serves
as investment adviser.
Frederic V. Malek; 60 Trustee Mr. Malek is chairman of
1455 Pennsylvania Avenue, Thayer Capital Partners
N.W. (merchant bank). From
Suite 350 January 1992 to Novem-
Washington, D.C. 20004 ber 1992, he was cam-
paign manager of Bush-
Quayle '92. From 1990
to 1992, he was vice
chairman and, from 1989
to 1990, he was presi-
dent of Northwest Air-
lines 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. (manage-
ment consulting and
computer related serv-
ices), Automatic Data
Processing,
</TABLE>
36
<PAGE>
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE POSITION WITH TRUSTS OTHER DIRECTORSHIPS
---------------------- -------------------- --------------------
<S> <C> <C>
Inc., CB Commercial
Group, Inc. (real es-
tate services), Choice
Hotels International
(hotel and hotel fran-
chising), FPL Group,
Inc. (electrical serv-
ices), Integra, Inc.
(bio-medical), Manor
Care, Inc. (health
care), National Educa-
tion Corporation and
Northwest Airlines Inc.
Mr. Malek is a director
or trustee of 28 other
investment companies
for which Mitchell
Hutchins or PaineWebber
serves as investment
adviser.
Carl W. Schafer; 61 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 is a direc-
tor of Roadway Express,
Inc. (trucking), The
Guardian Group of Mu-
tual Funds, Evans Sys-
tems, Inc. (motor fu-
els, convenience store
and diversified compa-
ny), Electronic Clear-
ing House, Inc. (finan-
cial 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 28 in-
vestment companies for
which Mitchell Hutchins
or PaineWebber serves
as investment adviser.
Julieanna Berry; 33 Vice President Ms. Berry is a vice
(Managed Investments president and a portfo-
Trust only) 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.
Karen L. Finkel; 39 Vice President Mrs. Finkel is a first
(Managed Investments vice president and a
Trust only) portfolio manager of
Mitchell Hutchins. Mrs.
Finkel is a vice presi-
dent of two investment
companies for which
Mitchell Hutchins or
PaineWebber serves as
investment adviser.
</TABLE>
37
<PAGE>
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE POSITION WITH TRUSTS OTHER DIRECTORSHIPS
---------------------- -------------------- --------------------
<S> <C> <C>
Donald R. Jones; 36 Vice President Mr. Jones is a first
(Securities Trust vice president and a
only) portfolio manager of
Mitchell Hutchins.
Prior to February
1996, he was a vice
president in the asset
management group of
First Fidelity Bancor-
poration. Mr. Jones is
a vice president of
one investment company
for which Mitchell
Hutchins or
PaineWebber serves as
investment adviser.
James F. Keegan; 36 Vice President Mr. Keegan is a senior
(Managed Investments vice president and a
Trust only) portfolio manager of
Mitchell Hutchins.
Prior to March 1996,
he was director of
fixed income strategy
and research of
Merrion Group, L.P.
From 1987 to 1994, he
was a vice president
of global investment
management of Bankers
Trust. Mr. Keegan is a
vice president of
three investment com-
panies for which
Mitchell Hutchins or
PaineWebber serves as
investment adviser.
Thomas J. Libassi; 38 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 port-
folio management re-
sponsibility. Mr.
Libassi is a vice
president of four in-
vestment companies for
which Mitchell
Hutchins or
PaineWebber serves as
investment 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
division of Mitchell
Hutchins. Mr. Maher is
a vice president and
assistant treasurer of
29 investment compa-
nies for which Mitch-
ell Hutchins or
PaineWebber serves as
investment adviser.
</TABLE>
38
<PAGE>
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE POSITION WITH TRUSTS OTHER DIRECTORSHIPS
---------------------- -------------------- --------------------
<S> <C> <C>
Dennis McCauley; 50 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; 39 Vice President and Ms. Moran is a vice
Assistant Treasurer president of Mitchell
Hutchins. Ms. Moran is
a vice president and
assistant treasurer of
29 investment companies
for which Mitchell
Hutchins or PaineWebber
serves as investment
adviser.
Dianne E. O'Donnell; 44 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 of 29 invest-
ment companies and sec-
retary of 28 investment
companies for which
Mitchell Hutchins or
PaineWebber serves as
investment adviser.
Emil Polito; 36 Vice President Mr. Polito is a senior
vice president and di-
rector of operations
and control for Mitch-
ell Hutchins. From
March 1991 to September
1993 he was director of
the Mutual Funds Sales
Support and Service
Center for Mitchell
Hutchins and
PaineWebber. Mr. Polito
is also a vice presi-
dent of 29 investment
companies for which
Mitchell Hutchins or
PaineWebber serves as
investment adviser.
Victoria E. Schonfeld; 46 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 29 invest-
ment companies for
which Mitchell Hutchins
or PaineWebber serves
as investment adviser.
</TABLE>
39
<PAGE>
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE POSITION WITH TRUSTS OTHER DIRECTORSHIPS
---------------------- -------------------- --------------------
<S> <C> <C>
Paul H. Schubert; 34 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 Inc. Prior
to August 1992, he was
an audit manager with
Ernst & Young LLP. Mr.
Schubert is a vice
president and assistant
treasurer of 29 invest-
ment companies for
which Mitchell Hutchins
or PaineWebber serves
as investment adviser.
Nirmal Singh; 41 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 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.
Julian F. Sluyters; 36 Vice President and Mr. Sluyters is a senior
Treasurer vice president and the
director of the mutual
fund finance division
of Mitchell Hutchins.
Mr. Sluyters is a vice
president and treasurer
of 29 investment compa-
nies for which Mitchell
Hutchins or PaineWebber
serves as investment
adviser.
Mark A. Tincher; 41 Vice President Mr. Tincher is a manag-
ing director and chief
investment officer--eq-
uities of Mitchell
Hutchins. Prior to
March 1995, he was a
vice president and di-
rected the U.S. funds
management and equity
research areas of Chase
Manhattan Private Bank.
Mr. Tincher is a vice
president of 13 invest-
ment companies for
which Mitchell Hutchins
or PaineWebber serves
as investment adviser.
</TABLE>
40
<PAGE>
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE POSITION WITH TRUSTS OTHER DIRECTORSHIPS
---------------------- -------------------- --------------------
<S> <C> <C>
Craig M. Varrelman; 38 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.
Stuart Waugh; 41 Vice President Mr. Waugh is a managing
(Securities Trust director and a
only) portfolio manager of
Mitchell Hutchins
responsible for global
fixed income
investments and
currency trading. Mr.
Waugh is a vice
president of five
investment companies
for which Mitchell
Hutchins or PaineWebber
serves as investment
adviser.
Keith A. Weller; 35 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
28 investment companies
for which Mitchell
Hutchins or PaineWebber
serves as investment
adviser.
Teresa M. West; 38 Vice President Ms. West is a first vice
president of Mitchell
Hutchins. Prior to No-
vember 1993, she was
compliance manager of
Hyperion Capital Man-
agement, Inc., an in-
vestment advisory firm.
Prior to April 1993,
Ms. West was a vice
president and manager--
legal administration of
Mitchell Hutchins. Ms.
West is a vice presi-
dent 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.
41
<PAGE>
Managed Investments Trust pays trustees who are not "interested persons" of
the Trust $1,000 annually for each series of the Trust. Securities Trust pays
trustees who are not "interested persons" of the Trust $1,000 for Strategic
Income Fund and $1,500 for the Trust's second series. Each Trust pays $150 for
each board meeting and each separate meeting of a board committee. Therefore,
Managed Investments Trust pays each such trustee $6,000 annually for its six
series, Securities Trust pays each such trustee $2,500 annually for its two
series and each Trust pays any additional amounts due for board or committee
meetings. Mr. Feldberg and another independent trustee to be elected by the
board serve as chairmen of the audit and contract review committees of
individual funds within the PaineWebber fund complex and receive additional
compensation, aggregating $15,000 each from the relevant funds. 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 Trusts and the Funds, the
Trusts require no employees. No officer, director or employee of Mitchell
Hutchins or PaineWebber presently receives any compensation from the Trusts for
acting as a trustee or officer.
The Table below includes certain information relating to the compensation of
each Trust's current trustees who held office with that Trust or other
PaineWebber funds during the fiscal year indicated.
COMPENSATION TABLE+
<TABLE>
<CAPTION>
TOTAL
AGGREGATE COMPENSATION
COMPENSATION FROM AGGREGATE FROM THE TRUSTS
THE MANAGED COMPENSATION FROM AND THE
NAME OF PERSON, POSITION INVESTMENTS TRUST* SECURITIES TRUST** TRUST COMPLEX***
- ------------------------ ------------------ ------------------ ----------------
<S> <C> <C> <C>
Richard Q. Armstrong,
Trustee ............... $4,139 $3,081 $59,873
Richard Burt, Trustee... $3,389 $2,781 $51,173
Meyer Feldberg,
Trustee................ $8,750 $1,664 $96,181
George W. Gowen,
Trustee................ $8,750 $1,664 $92,431
Frederic V. Malek,
Trustee................ $8,750 $1,664 $92,431
Carl W. Schafer,
Trustee................ $4,139 $1,664 $62,307
</TABLE>
- --------
+ Only independent members of the board are compensated by a 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, 1996.
** Represents fees paid to each trustee during the ten months ended November
30, 1996.
*** Represents total compensation paid to each trustee during the calendar year
ended December 31, 1996; no fund within the fund complex has a pension or
retirement plan.
PRINCIPAL HOLDERS OF SECURITIES. The Funds' records as of February 28, 1997,
indicate that no shareholder owned more than 5% of any Fund's shares.
42
<PAGE>
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 Managed
Investments Trust dated April 21, 1988, as supplemented by a separate fee
agreement dated March 26, 1993 with respect to Low Duration Income Fund, and a
contract dated January 29, 1993 with Securities Trust, as supplemented by a Fee
Agreement dated January 28, 1994 (each an "Advisory Contract"). Under the
Advisory Contracts, Strategic Income Fund pays Mitchell Hutchins an annual fee
of 0.75% of its average daily net assets and each of the four other Funds pays
Mitchell Hutchins an annual fee of 0.50% of its average daily net assets. All
fees paid under the Advisory Contracts are computed daily and paid monthly.
During each of the periods indicated, Mitchell Hutchins earned (or accrued)
advisory fees in the amounts set forth below:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED NOVEMBER 30,
------------------------------------
1996 1995 1994
------------ ----------- -----------
<S> <C> <C> <C>
U.S. Government Income Fund............. $2,517,534 $2,784,437 $3,958,127
Investment Grade Income Fund............ $1,685,067 $1,890,394 $1,897,899
High Income Fund........................ $2,656,610 $3,050,197 $4,047,201
Low Duration Income Fund................ $1,272,455 $1,839,876 $5,598,491
(of which
$400,611
was waived)
<CAPTION>
PERIOD
TEN MONTHS FISCAL YEAR FEBRUARY 7,
ENDED ENDED 1994* TO
NOVEMBER 30, JANUARY 31, JANUARY 31,
1996 1996 1995
------------ ----------- -----------
<S> <C> <C> <C>
Strategic Income Fund................... $ 407,534 $ 546,119 $ 603,881
</TABLE>
- --------
* Commencement of operations.
The Advisory Contracts authorize Mitchell Hutchins to retain one or more sub-
advisers but do 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 years ended November 30, 1996 and
November 30, 1995 and the period October 20, 1994 to November 30, 1994,
Mitchell Hutchins paid (or accrued) to PIMCO sub-advisory fees of $636,228,
$919,938 and $147,540, pursuant to the Sub-Advisory Contract and a
substantially similar prior contract.
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 each Trust's board annually, PaineWebber earned
(or accrued) the amounts set forth below during each of the periods indicated.
43
<PAGE>
<TABLE>
<CAPTION>
FISCAL YEAR ENDED NOVEMBER 30,
------------------------------------
1996 1995 1994
------------ ----------- -----------
<S> <C> <C> <C>
U.S. Government Income Fund............. $133,159 $154,428 $196,490
Investment Grade Income Fund............ $ 83,120 $ 99,641 $ 97,475
High Income Fund........................ $131,762 $158,323 $181,748
Low Duration Income Fund................ $ 70,807 $107,999 $139,291
<CAPTION>
PERIOD
TEN MONTHS FISCAL YEAR FEBRUARY 7,
ENDED ENDED 1994* TO
NOVEMBER 30, JANUARY 31, JANUARY 31,
1996 1996 1995
------------ ----------- -----------
<S> <C> <C> <C>
Strategic Income Fund................... $ 14,226 $ 19,823 $ 21,998
</TABLE>
- --------
* Commencement of operations
Under the terms of the Advisory Contracts, each Fund bears all expenses
incurred in its operation that are not specifically assumed by Mitchell
Hutchins. General expenses of a 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.
Under each 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 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
44
<PAGE>
not be liable for any error of judgment or mistake of law or for any loss
suffered by Managed Investments 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. Each Advisory Contract
terminates automatically with respect to each Fund upon assignment and is
terminable at any time without penalty by the applicable board 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 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 28, 1997,
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)......... $ 5,710.4
Global.................................... 2,938.1
Equity/Balanced........................... 3,579.3
Fixed Income (excluding Money Market)..... 5,069.2
Taxable Fixed Income................... 3,478.8
Tax-Free Fixed Income.................. 1,590.4
Money Market Funds........................ 24,668.5
</TABLE>
Mitchell Hutchins personnel may invest in securities for their own accounts
pursuant to a code of ethics that describes the fiduciary duty owed to
shareholders of 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.
45
<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 each Trust (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, 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 each Fund adopted by the Trusts 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 board 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 board, 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.
The Funds paid (or accrued) the following fees to Mitchell Hutchins under the
Class A, Class B and Class C Plans during the fiscal periods shown:
<TABLE>
<CAPTION>
INVESTMENT STRATEGIC
U.S. GOVERNMENT LOW DURATION GRADE HIGH INCOME INCOME
INCOME FUND INCOME FUND INCOME FUND FUND FUND
--------------- ------------ ------------ ------------ ------------------------
FISCAL YEAR FISCAL YEAR FISCAL YEAR FISCAL YEAR TEN MONTHS FISCAL YEAR
ENDED ENDED ENDED ENDED ENDED ENDED
NOVEMBER 30, NOVEMBER 30, NOVEMBER 30, NOVEMBER 30, NOVEMBER 30, JANUARY 31,
1996 1996 1996 1996 1996 1996
--------------- ------------ ------------ ------------ ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
Class A................. $948,991 $ 244,189 $597,257 $ 583,168 $ 19,708 $ 25,887
Class B................. 714,894 88,618 636,961 2,043,792 317,852 415,659
Class C................. 336,391 1,107,463 258,103 702,569 110,029 156,716
</TABLE>
46
<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 periods shown:
CLASS A
<TABLE>
<CAPTION>
INVESTMENT STRATEGIC
U.S. GOVERNMENT LOW DURATION GRADE HIGH INCOME INCOME
INCOME FUND INCOME FUND INCOME FUND FUND FUND
--------------- ------------ ------------ ------------ ------------------------
FISCAL YEAR FISCAL YEAR FISCAL YEAR FISCAL YEAR TEN MONTHS FISCAL YEAR
ENDED ENDED ENDED ENDED ENDED ENDED
NOVEMBER 30, NOVEMBER 30, NOVEMBER 30, NOVEMBER 30, NOVEMBER 30, JANUARY 31,
1996 1996 1996 1996 1996 1996
--------------- ------------ ------------ ------------ ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
Marketing and
advertising............ $ 73,288 $211,531 $ 52,608 $ 48,020 $ 8,925 $ 57,841
Printing of prospectuses
and statements of
additional information. 941 744 1,257 809 558 347
Branch network costs
allocated and interest
expense................ 349,595 350,745 256,083 287,703 13,682 25,190
Service fees paid to
investment executives.. 372,057 96,410 233,362 229,098 7,312 11,649
</TABLE>
CLASS B
<TABLE>
<CAPTION>
INVESTMENT STRATEGIC
U.S. GOVERNMENT LOW DURATION GRADE HIGH INCOME INCOME
INCOME FUND INCOME FUND INCOME FUND FUND FUND
--------------- ------------ ------------ ------------ ------------------------
FISCAL YEAR FISCAL YEAR FISCAL YEAR FISCAL YEAR TEN MONTHS FISCAL YEAR
ENDED ENDED ENDED ENDED ENDED ENDED
NOVEMBER 30, NOVEMBER 30, NOVEMBER 30, NOVEMBER 30, NOVEMBER 30, JANUARY 31,
1996 1996 1996 1996 1996 1996
--------------- ------------ ------------ ------------ ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
Marketing and
advertising............ $100,349 $ 72,394 $ 59,915 $ 76,864 $29,679 $271,864
Amortization of
commissions............ 291,401 31,790 240,872 1,026,367 145,870 147,793
Printing of prospectuses
and statements of
additional information. 1,289 248 1,434 1,295 1,854 1,629
Branch network costs
allocated and interest
expense................ 590,351 272,135 328,338 494,823 58,622 149,592
Service fees paid to
investment executives.. 70,123 8,670 62,224 209,650 29,451 46,762
</TABLE>
47
<PAGE>
CLASS C
<TABLE>
<CAPTION>
INVESTMENT STRATEGIC
U.S. GOVERNMENT LOW DURATION GRADE HIGH INCOME INCOME
INCOME FUND INCOME FUND INCOME FUND FUND FUND
--------------- ------------ ------------ ------------ ------------------------
FISCAL YEAR FISCAL YEAR FISCAL YEAR FISCAL YEAR TEN MONTHS FISCAL YEAR
ENDED ENDED ENDED ENDED ENDED ENDED
NOVEMBER 30, NOVEMBER 30, NOVEMBER 30, NOVEMBER 30, NOVEMBER 30, JANUARY 31,
1996 1996 1996 1996 1996 1996
--------------- ------------ ------------ ------------ ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
Marketing and
advertising............ $ 53,523 $155,582 $ 27,798 $ 32,508 $7,671 $129,542
Amortization of
commissions............ 85,591 286,383 60,044 165,732 29,568 41,673
Printing of prospectuses
and statements of
additional information. 687 558 737 547 479 777
Branch network costs
allocated and interest
expense................ 281,663 550,340 136,385 171,221 11,907 56,752
Service fees paid to
investment executives.. 44,069 145,132 32,481 96,212 11,166 17,631
</TABLE>
"Marketing and advertising" includes various internal costs allocated by
Mitchell Hutchins to its efforts at distributing Fund shares. These internal
costs encompass office rent, salaries and other overhead expenses of various
departments and areas of operations of Mitchell Hutchins. "Branch network costs
allocated and interest expense" consist of an allocated portion of the expenses
of various PaineWebber departments involved in the distribution of each Fund's
shares, including the PaineWebber retail branch system.
In approving the Funds' overall Flexible Pricing(SM) system of distribution,
each board 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, each board 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, each board considered all the features of the
distribution system, including (1) the conditions under which contingent
deferred sales charges would be imposed and
48
<PAGE>
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, each board considered all the features of the
distribution system, including (1) the advantage to investors in having no
initial sales charges deducted from the Fund's purchase payments and instead
having the entire amount of their purchase payments immediately invested in
Fund shares, (2) the advantage to investors in being free from contingent
deferred sales charges upon redemption 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 each Trust and Mitchell Hutchins for
the Class A shares and similar prior distribution contracts, for the periods
set forth below, Mitchell Hutchins
49
<PAGE>
earned the following approximate amounts of sales charges and retained the
following approximate amounts, net of concessions to PaineWebber as exclusive
dealer:
<TABLE>
<CAPTION>
FISCAL YEARS ENDED
NOVEMBER 30,
--------------------------
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
U.S. GOVERNMENT INCOME FUND
Earned......................................... $ 28,937 $ 41,959 $121,124
Retained....................................... 2,595 3,492 10,336
LOW DURATION INCOME FUND
Earned......................................... $ 3,734 $ 5,994 $892,216
Retained....................................... 211 3,637 494,591
INVESTMENT GRADE INCOME FUND
Earned......................................... $ 36,783 $ 48,610 $137,013
Retained....................................... 2,873 28,121 79,808
HIGH INCOME FUND
Earned......................................... $220,619 $297,694 $793,898
Retained....................................... 16,318 18,982 55,058
</TABLE>
<TABLE>
<CAPTION>
PERIOD
TEN MONTHS FISCAL YEAR FEBRUARY 7, 1994
ENDED ENDED (COMMENCEMENT
NOVEMBER 30, JANUARY 31, OF OPERATIONS) TO
1996 1996 JANUARY 31, 1995
------------ ----------- -----------------
<S> <C> <C> <C>
STRATEGIC INCOME FUND
Earned......................... $16,799 $7,392 $469,876
Retained....................... 1,110 415 32,555
</TABLE>
For the fiscal periods shown, 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>
INVESTMENT
U.S. GOVERNMENT LOW DURATION GRADE HIGH STRATEGIC
INCOME FUND INCOME FUND INCOME FUND INCOME FUND INCOME FUND
--------------- ------------ ----------- ----------- ------------------------
FISCAL YEAR FISCAL YEAR FISCAL YEAR FISCAL YEAR TEN MONTHS FISCAL YEAR
ENDED ENDED ENDED ENDED ENDED ENDED
NOVEMBER 30, NOVEMBER 30, NOVEMBER 30, NOVEMBER 30, NOVEMBER 30, JANUARY 31,
1996 1996 1996 1996 1996 1996
--------------- ------------ ------------ ------------ ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
Class A................. $ 0 $ 0 $ 0 $ 0 $ 0 $ 0
Class B................. 224,806 27,383 151,713 899,719 121,018 44,780
Class C................. 2,034 18,847 2,431 17,717 1,122 0
</TABLE>
PORTFOLIO TRANSACTIONS
Subject to policies established by each board, 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
50
<PAGE>
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 and
PIMCO generally seek reasonably competitive commission rates, payment of the
lowest commission is not necessarily consistent with obtaining the best net
results.
During the fiscal periods indicated, the Funds paid the brokerage commissions
set forth below:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED NOVEMBER 30,
------------------------------------
1996 1995 1994
------------ ----------- -----------
<S> <C> <C> <C>
U.S. Government Income Fund................ $ 0 $ 0 $ 0
Investment Grade Income Fund............... $ 2,400 $ 0 $21,500
High Income Fund........................... $32,596 $ 0 $74,838
Low Duration Income Fund................... $ 0 $ 0 $88,421
<CAPTION>
PERIOD
TEN MONTHS FISCAL YEAR FEBRUARY 7,
ENDED ENDED 1994* TO
NOVEMBER 30, JANUARY 31, JANUARY 31,
1996 1996 1995
------------ ----------- -----------
<S> <C> <C> <C>
Strategic Income Fund...................... $0 $0 $0
</TABLE>
- --------
* Commencement of operations
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. Each board 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 each
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
last three fiscal years or periods indicated above, no Fund paid any brokerage
commissions to PaineWebber or any other affiliate of Mitchell Hutchins, except
that, during the fiscal year ended November 30, 1994, High Income Fund paid
approximately $30,915 in brokerage commissions to PaineWebber.
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.
51
<PAGE>
Consistent with the interests of a Fund and subject to the review of the
applicable board, 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, 1996, 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.
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.
52
<PAGE>
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 a board
pursuant to Rule 10f-3 under the 1940 Act. Among other things, these procedures
require that the commission or spread paid in connection with such a purchase
be reasonable and fair, that the purchase be at not more than the public
offering price prior to the end of the first business day after the date of the
public offering and that Mitchell Hutchins or any affiliate thereof not
participate in or benefit from the sale to the Fund.
PORTFOLIO TURNOVER. The turnover rate may vary greatly from year to year for
any Fund and will not be a limiting factor when Mitchell Hutchins or PIMCO
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 period indicated, the portfolio turnover rates were as set
forth below:
<TABLE>
<CAPTION>
PORTFOLIO TURNOVER RATES
FOR THE YEARS
ENDED NOVEMBER 30,
---------------------------
FUND 1996 1995
---- ------------ ------------
<S> <C> <C>
U.S. Government Income Fund*................... 359% 206%
Investment Grade Income Fund................... 115% 149%
High Income Fund............................... 142% 94%
Low Duration Income Fund....................... 210% 242%
</TABLE>
<TABLE>
<CAPTION>
PERIOD
TEN MONTHS ENDED FISCAL YEAR ENDED FEBRUARY 7, 1994**
NOVEMBER 30, 1996 JANUARY 31, 1996 TO JANUARY 31, 1995
----------------- ----------------- -------------------
<S> <C> <C> <C>
Strategic Income Fund... 101% 91% 117%
</TABLE>
- --------
* Portfolio turnover was significantly higher for the fiscal year ending
November 30, 1996 due to greater volatility in the bond market, more frequent
rebalancing of the Fund's duration and an increase number of transactions in
mortgage-backed securities on a forward commitment ("TBA") basis.
** Commencement of Operations
53
<PAGE>
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
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
54
<PAGE>
one year following the death of the shareholder. The contingent deferred sales
charge waiver is available where the decedent is either the sole shareholder or
owns the shares with his or her spouse as a joint tenant with right of
survivorship. This waiver applies only to redemption of shares held at the time
of death.
Certain PaineWebber mutual funds offered shares subject to contingent
deferred sales charges before the implementation of the Flexible Pricing system
on July 1, 1991 ("CDSC Funds"). The contingent deferred sales charge is waived
with respect to redemptions of Class B shares of CDSC Funds purchased prior to
July 1, 1991 by officers, directors (trustees) or employees of the CDSC Funds,
Mitchell Hutchins or their affiliates (or their spouses and children under age
21). In addition, the contingent deferred sales charge will be reduced by 50%
with respect to redemptions of Class B shares of CDSC Funds purchased prior to
July 1, 1991 with a net asset value at the time of purchase of at least $1
million. If Class B shares of a CDSC Fund purchased prior to July 1, 1991 are
exchanged for Class B shares of 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. Each 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.
AUTOMATIC INVESTMENT PLAN. Participation in the Automatic Investment Plan
enables an investor to use the technique of "dollar cost averaging." When the
investor invests the same dollar amount each month under the plan, the investor
will purchase more shares when a Fund's net asset value per share is low and
fewer shares when the net asset value per share is high. Using this technique,
an investor's average purchase price per share over any given period will be
lower than if the investor purchased a fixed number of shares on a monthly
basis during the period. Of course,
55
<PAGE>
investing through the automatic investment plan does not assure a profit or
protect against loss in declining markets. Additionally, because the automatic
investment plan involves continuous investing regardless of price levels, an
investor should consider his or her financial ability to continue purchases
through periods of low price levels.
SYSTEMATIC WITHDRAWAL PLAN. An investor's participation in the systematic
withdrawal plan will terminate automatically if the "Initial Account Balance"
(a term that means the value of the Fund account at the time the investor
elects to participate in the systematic withdrawal plan) less aggregate
redemptions made other than pursuant to the systematic withdrawal plan is less
than $5,000 for Class A and Class C shareholders or $20,000 for Class B
shareholders. Purchases of additional Fund shares concurrent with withdrawals
are ordinarily disadvantageous to shareholders because of tax liabilities and,
for Class A shares, initial sales charges. 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 three Business Days (defined under "Valuation of Shares")
after the redemption date. Withdrawal payments should not be considered
dividends but redemption proceeds, with the tax consequences described under
"Dividends & 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 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 & 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
56
<PAGE>
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.
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;
57
<PAGE>
. 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 six RMA money market funds--RMA Money Market Portfolio, RMA U.S.
Government Portfolio, RMA Tax-Free Fund, RMA California 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;
. 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 (defined under
"Valuation of Shares") of the month in which the sixth anniversary of the
initial issuance of such Class B shares 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.
58
<PAGE>
The availability of the conversion feature is subject to the continuing
availability of an opinion of counsel to the effect 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 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 this condition for the availability of the conversion feature will not 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 closed on the observance of
the following holidays: New Year's Day, Presidents' Day, Good Friday, Memorial
Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
Securities that are listed on exchanges are valued at the last sale price on
the day the securities are being valued or, lacking any sales on such day, at
the last available bid price. In cases where securities are traded on more than
one exchange, the securities are generally valued on the exchange considered by
Mitchell Hutchins as the primary market. Securities traded in the OTC market
and listed on The Nasdaq Stock Market are valued at the last available sale
price on The Nasdaq Stock Market at 4:00 p.m., Eastern time; other OTC
securities are valued at the last bid price available prior to valuation.
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. All other securities or assets will be valued at fair
value as determined in good faith by or under the direction of the applicable
board. All investments of High Income Fund and Strategic 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 or Strategic 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
applicable board. The foreign currency exchange transactions of High Income
Fund and Strategic 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.
59
<PAGE>
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.
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.
60
<PAGE>
The following tables show 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>
Year ended November
30, 1996:
Standardized
Return*.......... (0.75)% (2.28)% 2.23% 3.37% 2.60% 5.07% 2.03% 0.54% 5.05% 11.89% 10.86% 15.21%
Non-Standardized
Return........... 3.39% 2.72% 2.98% 6.46% 5.60% 5.82% 6.33% 5.54% 5.80% 16.55% 15.86% 15.96%
Inception** to
November 30, 1996:
Standardized
Return*.......... 7.80% 4.45% 2.91% 2.87% 2.69% 3.21% 9.81% 8.26% 7.12% 10.67% 12.24% 8.96%
Non-Standardized
Return........... 8.16% 4.60% 2.91% 3.78% 2.95% 3.21% 10.18% 8.34% 7.12% 11.04% 12.35% 8.96%
Five years ended
November 30, 1996:
Standardized
Return*.......... 3.57% 3.28% NA NA NA NA 7.66% 7.41% NA 10.85% 10.66% NA
Non-Standardized
Return........... 4.43% 3.63% NA NA NA NA 8.53% 7.20% NA 11.75% 10.93% NA
Ten years ended
November 30, 1996:
Standardized
Return*.......... 5.96% NA NA NA NA NA 7.77% NA NA 8.85% NA NA
Non-Standardized
Return........... 6.39% NA NA NA NA NA 8.32% NA NA 9.30% NA NA
</TABLE>
<TABLE>
<CAPTION>
STRATEGIC INCOME FUND
-----------------------
CLASS A CLASS B CLASS C
------- ------- -------
<S> <C> <C> <C>
Year ended November 30, 1996:
Standardized Return*.................................. 10.96% 9.69% 14.32%
Non-Standardized Return*.............................. 15.60% 14.69% 15.07%
Inception** to November 30, 1996:
Standardized Return*.................................. 4.63% 4.42% 5.68%
Non-Standardized Return*.............................. 6.18% 5.40% 5.68%
</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. For Strategic Income Fund, the
inception date for Class A, Class B and Class C shares was February 7, 1994.
61
<PAGE>
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) 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, 1996.
<TABLE>
<CAPTION>
U.S. GOVERNMENT LOW DURATION INVESTMENT GRADE HIGH INCOME STRATEGIC INCOME
INCOME FUND INCOME FUND INCOME FUND FUND FUND
--------------- ------------ ---------------- ----------- ----------------
<S> <C> <C> <C> <C> <C>
Class A................. 5.61% 5.78% 6.84% 9.06% 7.17%
Class B................. 5.09% 5.14% 6.38% 8.68% 6.72%
Class C................. 5.35% 5.37% 6.62% 8.94% 6.97%
</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
62
<PAGE>
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 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.
63
<PAGE>
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 and Strategic 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 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, Investment Grade Income Fund and Strategic 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 and Strategic
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.
64
<PAGE>
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 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, forward
currency contracts and/or foreign currency positions 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 OID. As a
holder of such securities, a Fund would have to include in its gross income the
portion of 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 and Strategic Income Fund must include in their
gross income securities they receive 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, or foreign currency positions held for less than
three months that it might wish to sell in the ordinary course of its portfolio
management.
65
<PAGE>
OTHER INFORMATION
PaineWebber Managed Investments Trust and PaineWebber Securities Trust are
entities of the type commonly known as "Massachusetts business trusts." Under
Massachusetts law, shareholders could, under certain circumstances, be held
personally liable for the obligations of each Trust or a Fund. However, each
Trust's Declaration of Trust disclaims shareholder liability for acts or
obligations of the Trust or a Fund and requires that notice of such disclaimer
be given in each note, bond, contract, instrument, certificate or undertaking
made or issued by the trustees or by any officers or officer by or on behalf of
the Trust, a Fund, the trustees or any of them in connection with the Trust.
Each Declaration of Trust provides for indemnification from the relevant 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.
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 five Funds were called "Class D" shares.
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, serves as counsel to the Funds.
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 PaineWebber Managed Investments
Trust. Price Waterhouse, LLP, 1177 Avenue of the Americas, New York, NY 10036,
serves as independent accountants for Strategic Income Fund.
66
<PAGE>
FINANCIAL STATEMENTS
The Funds' Annual Reports to Shareholders for the fiscal periods ended
November 30, 1996 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.
67
<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...................................... 2
Hedging and Other Strategies Using Derivative Contracts................... 22
Trustees and Officers; Principal Holders of Securities.................... 34
Investment Advisory and Distribution Arrangements......................... 43
Portfolio Transactions.................................................... 50
Reduced Sales Charges, Additional Exchange and Redemption Information and
Other Services........................................................... 54
Conversion of Class B Shares.............................................. 58
Valuation of Shares....................................................... 59
Performance Information................................................... 60
Taxes..................................................................... 64
Other Information......................................................... 66
Financial Statements...................................................... 67
</TABLE>
(C) 1997 PaineWebber Incorporated
PAINEWEBBER
U.S. GOVERNMENT
INCOME FUND
LOW DURATION
U.S. GOVERNMENT INCOME FUND
INVESTMENT GRADE
INCOME FUND
HIGH INCOME FUND
STRATEGIC INCOME FUND
- --------------------------------------------------------------------------------
Statement of Additional Information
April 1, 1997
- --------------------------------------------------------------------------------
PAINEWEBBER
