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 are series of professionally managed open-end
management investment companies (each a "Trust"). PaineWebber U.S. Government
Income Fund, PaineWebber Low Duration U.S. Government Income Fund ("Low Duration
Fund"), PaineWebber Investment Grade Income Fund and PaineWebber High Income
Fund are diversified series of PaineWebber Managed Investments Trust ("Managed
Trust"). PaineWebber Strategic Income Fund is a non-diversified series of
PaineWebber Securities Trust ("Securities Trust").
The investment adviser, administrator and distributor for each fund is
Mitchell Hutchins Asset Management Inc. ("Mitchell Hutchins"), a wholly owned
asset management subsidiary of PaineWebber Incorporated ("PaineWebber"). As
distributor for the funds, Mitchell Hutchins has appointed PaineWebber to serve
as the exclusive dealer for the sale of fund shares. Pacific Investment
Management Company ("PIMCO" or "sub-adviser") serves as sub-adviser for Low
Duration Fund.
Portions of each fund's Annual Report to Shareholders are incorporated by
reference into this Statement of Additional Information. The Annual Reports
accompany this Statement of Additional Information. You may obtain an additional
copy of a fund's Annual Report by calling toll-free 1-800-647-1568.
This Statement of Additional Information is not a prospectus and should be
read only in conjunction with the funds' current Prospectus, dated March 31,
1999. A copy of the Prospectus may be obtained by calling any PaineWebber
Financial Advisor or correspondent firm or by calling toll-free 1-800-647-1568.
This Statement of Additional Information is dated March 31, 1999.
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THE FUNDS AND THEIR INVESTMENT POLICIES
No fund's investment objective may be changed without shareholder
approval. Except where noted, the other investment policies of each fund may be
changed by its board without shareholder approval. As with other mutual funds,
there is no assurance that a fund will achieve its investment objective.
U.S. GOVERNMENT INCOME FUND AND LOW DURATION FUND. U.S. Government Income
Fund's investment objective is high current income consistent with the
preservation of capital and liquidity. Low Duration Fund's investment objective
is to achieve the highest level of income consistent with the preservation of
capital and low volatility of net asset value.
Low Duration Fund seeks to limit (but not eliminate) the volatility of net
asset value by normally maintaining an overall portfolio duration between one to
three years. U.S. Government Income Fund has no fixed portfolio duration policy.
"Duration" is a measure of the expected life of a fixed income security on a
present value basis and thus is a measure of interest rate risk.
Each fund normally invests at least 65% of its total assets in U.S.
government bonds (including mortgage-backed securities) and repurchase
agreements with respect to them. Each fund may invest up to 35% of its total
assets in privately issued mortgage-backed and asset-backed securities that, at
the time of purchase, are rated in the highest rating category by Standard &
Poor's, a division of The McGraw-Hill Companies, Inc. ("S&P"), Moody's Investors
Service, Inc. ("Moody's") or another nationally or internationally recognized
statistical rating organization ("rating agency") or, if unrated, are considered
to be of comparable quality by Mitchell Hutchins or, for Low Duration Fund, the
sub-adviser.
Each fund has a fundamental policy of normally concentrating at least 25%
of its total assets in U.S. government and privately issued mortgage- and
asset-backed securities. This policy has the effect of increasing each fund's
exposure to the risks of these securities and might cause a fund's net asset
value to fluctuate more than otherwise would be the case. Some types of
mortgage-backed securities, including "interest only," "principal only" and
inverse floating classes of these securities, can be extremely volatile and may
become illiquid. Low Duration Fund does not invest in these classes of
mortgage-backed securities.
Each fund normally invests at least 65% of its total assets in
income-producing securities, which may include zero coupon bonds, other original
issue discount securities and (for U.S. Government Income Fund) principal-only
mortgage-backed securities.
U.S. Government Income Fund may invest up to 10% of its net assets in
illiquid securities. Low Duration Fund may invest up to 15% of its net assets in
illiquid securities. Each fund may lend its portfolio securities to qualified
broker-dealers or institutional investors in an amount up to 33-1/3% of its
total assets. Each fund may purchase securities on a when-issued or delayed
delivery basis. Each fund may engage in dollar rolls and reverse repurchase
agreements, which are considered borrowings and may not exceed 33-1/3% of its
total assets. Each fund may also borrow for temporary or emergency purposes, but
not in excess of an additional 5% of its total assets. Each fund may invest in
the securities of other investment companies and may sell short "against the
box."
INVESTMENT GRADE INCOME FUND'S investment objective is to provide high
current income consistent with the preservation of capital and liquidity. The
fund normally invests at least 65% of its total assets in U.S. government and
investment grade corporate bonds, including mortgage-backed securities and money
market instruments. The fund's investments in money market instruments may
include repurchase agreements and commercial paper or variable amount master
notes whose issuers, at the time the security is purchased by the fund, have
outstanding either long-term bonds that are rated investment grade by S&P or
Moody's or commercial paper rated in the highest rating category by S&P or
Moody's. The fund also may invest up to 35% of its total assets in (1) corporate
bonds that are below investment grade, (2) preferred stocks, (3) convertible
securities and (4) asset-backed securities other than mortgage-backed
securities.
Investment Grade Income Fund's ability to invest in mortgage- and
asset-backed securities is limited. The fund may invest in mortgage-backed
securities only if they are U.S. government issued or guaranteed or if, at the
time of purchase, they are investment grade. The fund may invest in asset-backed
securities only if, at the time of purchase, they are rated in one of the two
highest rating categories by S&P or Moody's. Also, the fund may not invest more
than 10% of its total assets in interest only and principal only classes of
mortgage-backed securities.
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Up to 20% of Investment Grade Income Fund's net assets may be invested in
certain foreign securities. These are (1) U.S. dollar-denominated securities of
foreign issuers or of foreign branches of U.S. banks that are traded in the U.S.
securities markets and (2) securities that are U.S. dollar-denominated but whose
value is linked to the value of foreign currencies.
Investment Grade Income Fund normally invests at least 65% of its total
assets in income-producing securities, which may include zero coupon bonds,
other original issue discount securities, payment-in-kind securities and
principal only mortgage-backed securities. The fund also may invest up to 5% of
its net assets in fixed and floating rate loans through either participations in
or assignments of all or a portion of loans made by banks.
Investment Grade Income Fund may invest up to 10% of its net assets in
illiquid securities. The fund may purchase securities on a when-issued or
delayed delivery basis. The fund may lend its portfolio securities to qualified
broker-dealers or institutional investors in an amount up to 33-1/3% of its
total assets. The fund may borrow money from banks or through reverse repurchase
agreements for temporary or emergency purposes but not in excess of 10% of its
total assets. The fund may invest in the securities of other investment
companies and may sell short "against the box."
HIGH INCOME FUND'S investment objective is to provide high income. The
fund normally invests at least 65% of its total assets in high yield, income
producing corporate bonds that, at the time of purchase, are rated B or better
by S&P or Moody's, are comparably rated by another rating agency or, if unrated,
are considered to be of comparable quality by Mitchell Hutchins. The fund may
include in this 65% of its total assets any equity securities (including common
stocks and rights and warrants for equity securities) that are attached to
corporate bonds or are part of a unit including corporate bonds, so long as the
corporate bonds meet these quality requirements. The fund also may invest up to
35% of its total assets in (1) bonds that are rated below B (and rated as low as
D by S&P or C by Moody's) or comparable unrated bonds, (2) U.S. government
bonds, (3) equity securities and (4) money market instruments, including
repurchase agreements.
Up to 35% of High Income Fund's net assets may be invested in securities
of foreign issuers, including securities that are U.S. dollar-denominated but
whose value is linked to the value of foreign currencies. However, no more than
10% of the fund's net assets may be invested in securities of foreign issuers
that are denominated and traded in currencies other than the U.S. dollar.
Up to 25% of High Income Fund's total assets may be invested in bonds and
equity securities that are not paying current income. The fund may purchase
these securities if Mitchell Hutchins believes they have a potential for capital
appreciation.
High Income Fund normally invests at least 65% of its total assets in
income-producing securities, which may include zero coupon bonds, other original
issue discount securities, payment-in-kind securities and principal only
mortgage backed securities. The fund also may invest up to 5% of its net assets
in fixed and floating rate loans through either participations in or assignments
of all or a portion of loans made by banks.
High Income Fund may invest up to 10% of its net assets in illiquid
securities. The fund may purchase securities on a when-issued or delayed
delivery basis. The fund may lend its portfolio securities to qualified
broker-dealers or institutional investors in an amount up to 33-1/3% of its
total assets. The fund may borrow money from banks or through reverse repurchase
agreements for temporary or emergency purposes but not in excess of 10% of its
total assets. The fund may invest in the securities of other investment
companies and may sell short "against the box."
STRATEGIC INCOME FUND'S primary investment objective is to achieve a high
level of current income. As a secondary investment objective, the fund seeks
capital appreciation. The fund strategically allocates its investments among
three distinct bond market categories: (1) U.S. government and investment grade
corporate bonds, including mortgage- and asset-backed securities; (2) U.S. high
yield corporate bonds, including convertible bonds, and preferred stock; and (3)
foreign and emerging market bonds. A portion of the fund's assets normally is
invested in each of these investment sectors. However, the fund has the
flexibility at any time to invest all or substantially all of its investments in
any one sector.
Strategic Income Fund may invest in high yield bonds that are rated as low
as D by S&P or C by Moody's.
The foreign and emerging market bonds in which Strategic Income Fund may
invest include (1) government bonds, including Brady bonds and other sovereign
debt, and bonds issued by multi-national institutions such as the International
Bank for Reconstruction and Development and the International Monetary Fund, (2)
corporate bonds and preferred stock issued by entities located in foreign
countries, or denominated in or indexed to foreign currencies, (3) interests in
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foreign loan participations and assignments, and (4) foreign mortgage-backed
securities and other structured foreign investments. The fund may invest without
limit in securities of issuers located in any country in the world, including
both industrialized and emerging market countries. The fund generally is not
restricted in the portion of its assets that may be invested in a single country
or region, but its assets normally are invested in issuers located in at least
three countries. No more than 25% of the fund's total assets are invested in
securities issued or guaranteed by any single foreign government. The fund may
invest in foreign and emerging market bonds that do not meet any minimum credit
rating standard or that are unrated.
Mitchell Hutchins believes that Strategic Income Fund's strategy of sector
allocation should be less risky than investing in only one sector of the bond
market. Data from the Lehman Aggregate Bond Index, the Salomon Brothers High
Yield Index, the Merrill Lynch High Yield Index and the Salomon Brothers World
Government Bond Index indicate that these sectors are not closely correlated. If
successful, the fund's strategy should enable it to achieve a higher level of
investment return than if it invested exclusively in any one investment sector
or allocated a fixed proportion of its assets to each investment sector.
Strategic Income Fund may invest up to 10% of its total assets in
preferred stock of U.S. and foreign issuers. It also may acquire equity
securities when attached to bonds or as part of a unit including bonds or in
connection with a conversion or exchange of bonds. The fund also may invest
without limit in certificates of deposit issued by banks and savings
associations and in bankers' acceptances.
Strategic Income Fund normally invests at least 65% of its total assets in
income-producing securities, which may include zero coupon bonds, other original
issue discount securities, payment-in-kind securities and principal only
mortgage-backed securities. The fund also may invest in fixed and floating rate
loans through either participations in or assignments of all or a portion of
loans made by banks.
Strategic Income Fund may invest up to 15% of its net assets in illiquid
securities. The fund may purchase securities on a when-issued or delayed
delivery basis. The fund may lend its portfolio securities to qualified
broker-dealers or institutional investors in an amount up to 33-1/3% of its
total assets. The fund may engage in dollar rolls and reverse repurchase
agreements, which are considered borrowings and may not exceed 33-1/3% of its
total assets. The fund may also borrow for temporary or emergency purposes, but
not in excess of an additional 5% of its total assets. The fund may invest in
the securities of other investment companies and may sell short "against the
box."
THE FUNDS' INVESTMENTS, RELATED RISKS AND LIMITATIONS
The following supplements the information contained in the Prospectus and
above concerning the funds' investments, related risks and limitations. Except
as otherwise indicated in the Prospectus or the Statement of Additional
Information, the funds have established no policy limitations on their ability
to use the investments or techniques discussed in these documents.
BONDS are fixed or variable rate debt obligations, including notes,
debentures, and similar instruments and securities and various money market
instruments. Mortgage- and asset-backed securities are types of bonds, and
certain types of income-producing, non-convertible preferred stocks may be
treated as bonds for investment purposes. Bonds generally are used by
corporations, governments and other issuers to borrow money from investors. The
issuer pays the investor a fixed or variable rate of interest and normally must
repay the amount borrowed on or before maturity. Many preferred stocks and some
bonds are "perpetual" in that they have no maturity date.
Bonds are subject to interest rate risk and credit risk, but to varying
degrees. Interest rate risk is the risk that interest rates will rise and that,
as a result, bond prices will fall, lowering the value of a fund's investments
in bonds. In general, bonds having longer durations are more sensitive to
interest rate changes than are bonds with shorter durations. Credit risk is the
risk that an issuer may be unable or unwilling to pay interest and/or principal
on the bond, or that a market may become less confident as to the issuer's
ability or willingness to do so. Credit risk can be affected by many factors,
including adverse changes in the issuer's own financial condition or in economic
conditions.
EQUITY SECURITIES. Equity securities include common stocks, most preferred
stocks and securities that are convertible into them, including common stock
purchase warrants and rights, equity interests in trusts, partnerships, joint
ventures or similar enterprises and depository receipts. Common stocks are the
most familiar type of equity security. They represent an equity (ownership)
interest in a corporation.
Preferred stock has certain fixed income features, like a bond, but is
actually equity in a company, like common stock. Convertible securities include
debentures, notes and preferred equity securities, that may be converted into or
exchanged for a prescribed amount of common stock of the same or a different
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issuer within a particular period of time at a specified price or formula.
Depository receipts typically are issued by banks or trust companies and
evidence ownership of underlying equity securities.
The prices of equity securities generally fluctuate more than bonds and
reflect changes in a company's financial condition and in overall market and
economic conditions. Common stocks generally represent the riskiest investment
in a company. It is possible that a fund may experience a substantial or
complete loss on an individual equity investment. While this is possible with
bonds, it is less likely.
CREDIT RATINGS; NON-INVESTMENT GRADE BONDS. Moody's, S&P and other rating
agencies are private services that provide ratings of the credit quality of
bonds and certain other securities. A description of the ratings assigned to
corporate bonds by Moody's and S&P is included in the Appendix to this Statement
of Additional Information. The process by which Moody's and S&P determine
ratings for mortgage-backed securities includes consideration of the likelihood
of the receipt by security holders of all distributions, the nature of the
underlying assets, the credit quality of the guarantor, if any, and the
structural, legal and tax aspects associated with these securities. Not even the
highest such ratings represents an assessment of the likelihood that principal
prepayments will be made by obligors on the underlying assets 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.
Credit ratings attempt to evaluate the safety of principal and interest
payments, but they do not evaluate the volatility of a bond's value or its
liquidity and do not guarantee the performance of the issuer. 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. There is a risk that rating agencies may downgrade a
bond's rating. Subsequent to a bond's purchase by a fund, it may cease to be
rated or its rating may be reduced below the minimum rating required for
purchase by the fund. The funds 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,
bonds with the same maturity, interest rate and rating may have different market
prices.
In addition to ratings assigned to individual bond issues, Mitchell
Hutchins or the sub-adviser 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 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.
Investment grade bonds are rated in one of the four highest rating
categories by Moody's or S&P, comparably rated by another rating agency or, if
unrated, determined by Mitchell Hutchins or the sub-adviser to be of comparable
quality. Moody's considers bonds rated Baa (its lowest investment grade rating)
to have speculative characteristics. This means that changes in economic
conditions or other circumstances are more likely to lead to a weakened capacity
to make principal and interest payments than is the case for higher rated bonds.
High yield bonds (commonly known as "junk bonds") are non-investment grade
bonds. This means they are rated Ba or lower by Moody's, BB or lower by S&P,
comparably rated by another rating agency or determined by Mitchell Hutchins or
the sub-adviser to be of comparable quality. A fund's investments in
non-investment grade bonds entail greater risk than its investments in higher
rated bonds. Non-investment grade bonds are considered predominantly speculative
with respect to the issuer's ability to pay interest and repay principal and may
involve significant risk exposure to adverse conditions. Non-investment grade
bonds generally offer a higher current yield than that available for investment
grade issues; however, they involve higher risks, in that they are especially
sensitive 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 by
collateral and will not receive payment until more senior claims are paid in
full.
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The market for non-investment grade bonds, especially those of foreign
issuers, has expanded rapidly in recent years, which has been a period of
generally expanding growth and lower inflation. These securities will be
susceptible to greater risk when economic growth slows or reverses and when
inflation increases or deflation occurs. This has been reflected in recent
volatility in emerging market securities. In the past, many lower rated bonds
experienced substantial price declines reflecting an expectation that many
issuers of such securities might experience financial difficulties. As a result,
the yields on lower rated bonds rose dramatically. However, those higher yields
did not reflect the value of the income stream that holders of such securities
expected. Rather, they reflected the risk that holders of such securities could
lose a substantial portion of their value due to the issuers' financial
restructurings or defaults by the issuers. There can be no assurance that those
declines will not recur.
The market for non-investment grade bonds generally is thinner and 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
non-investment grade bonds, especially in a thinly traded market.
U.S. GOVERNMENT SECURITIES include direct obligations of the U.S. Treasury
(such as Treasury bills, notes or bonds) and obligations issued or guaranteed as
to principal and interest (but not as to market value) by the U.S. government,
its agencies or its instrumentalities. U.S. government securities include
mortgage-backed securities issued or guaranteed by government agencies or
government-sponsored enterprises. Other U.S. government securities may be backed
by the full faith and credit of the U.S. government or supported primarily or
solely by the creditworthiness of the government-related issuer or, in the case
of mortgage-backed securities, by pools of assets.
Treasury inflation-protected securities ("TIPS") are Treasury bonds on
which the principal value is adjusted daily in accordance with changes in the
Consumer Price Index. Interest on TIPS is payable semi-annually on the adjusted
principal value. The principal value of TIPS would decline during periods of
deflation, but the principal amount payable at maturity would not be less than
the original par amount. If inflation is lower than expected while a fund holds
TIPS, the fund may earn less on the TIPS than it would on conventional Treasury
bonds.
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 sales
contracts, other installment sales 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 interests in pools of underlying mortgage loans that are secured by
real property. U.S. government mortgage-backed securities are issued or
guaranteed as to the payment of principal and interest (but not as to market
value) by Ginnie Mae (also known as the Government National Mortgage
Association), Fannie Mae (also known as the Federal National Mortgage
Association), Freddie Mac (also known as the Federal Home Loan Mortgage
Corporation) or other government sponsored enterprises. Other domestic
mortgage-backed securities are sponsored or issued by private entities,
generally originators of and investors in mortgage loans, including savings
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. Foreign mortgage-backed
securities may be issued by mortgage banks and other private or governmental
entities outside the United States and are supported by interests in foreign
real estate.
Mortgage-backed securities may be composed of one or more classes and may
be structured either as pass-through securities or collateralized debt
obligations. Multiple-class mortgage-backed securities are referred to herein as
"CMOs." Some CMOs are directly supported by other CMOs, which in turn are
supported by mortgage pools. Investors typically receive payments out of the
interest and principal on the underlying mortgages. The portions of these
payments that investors receive, as well as the priority of their rights to
receive payments, are determined by the specific terms of the CMO class. CMOs
involve special risk and evaluating them requires special knowledge.
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A major difference between mortgage-backed securities and traditional
bonds is that interest and principal payments are made more frequently (usually
monthly) and that principal may be repaid at any time because the underlying
mortgage loans may be prepaid at any time. When interest rates go down and
homeowners refinance their mortgages, mortgage-backed securities may be paid off
more quickly than investors expect. When interest rates rise, mortgage-backed
securities may be paid off more slowly than originally expected. Changes in the
rate or "speed" of these prepayments can cause the value of mortgage-backed
securities to fluctuate rapidly.
Mortgage-backed securities also may decrease in value as a result of
increases in interest rates and, because of prepayments, may benefit less than
other bonds from declining interest rates. Reinvestments of prepayments may
occur at lower interest rates than the original investment, thus adversely
affecting a fund's yield. Actual prepayment experience may cause the yield of a
mortgage-backed security to differ from what was assumed when the fund purchased
the security. Prepayments at a slower rate than expected may lengthen the
effective life of a mortgage-backed security. The value of securities with
longer effective lives generally fluctuates more widely in response to changes
in interest rates than the value of securities with shorter effective lives.
CMO classes may be specially structured in a manner that provides any of a
wide variety of investment characteristics, such as yield, effective maturity
and interest rate sensitivity. As market conditions change, however, and
particularly during periods of rapid or unanticipated changes in market interest
rates, the attractiveness of the CMO classes and the ability of the structure to
provide the anticipated investment characteristics may be significantly reduced.
These changes can result in volatility in the market value, and in some
instances reduced liquidity, of the CMO class.
Certain classes of CMOs and other mortgage-backed securities are
structured in a manner that makes them extremely sensitive to changes in
prepayment rates. Interest only ("IO") and principal only ("PO") classes are
examples of this. IOs are entitled to receive all or a portion of the interest,
but none (or only a nominal amount) of the principal payments, from the
underlying mortgage assets. If the mortgage assets underlying an IO experience
greater than anticipated principal prepayments, then the total amount of
interest payments allocable to the IO class, and therefore the yield to
investors, generally will be reduced. In some instances, an investor in an IO
may fail to recoup all of his or her initial investment, even if the security is
government issued or guaranteed or is rated AAA or the equivalent. Conversely,
PO classes are entitled to receive all or a portion of the principal payments,
but none of the interest, from the underlying mortgage assets. PO classes are
purchased at substantial discounts from par, and the yield to investors will be
reduced if principal payments are slower than expected. Some IOs and POs, as
well as other CMO classes, are structured to have special protections against
the effects of prepayments. These structural protections, however, normally are
effective only within certain ranges of prepayment rates and thus will not
protect investors in all circumstances. Inverse floating rate CMO classes also
may be extremely volatile. These classes pay interest at a rate that decreases
when a specified index of market rates increases and vice versa.
The market for privately issued mortgage-backed securities is smaller and
less liquid than the market for U.S. government mortgage-backed securities.
Foreign mortgage-backed securities markets are substantially smaller than U.S.
markets, but have been established in several countries, including Germany,
Denmark, Sweden, Canada and Australia, and may be developed elsewhere. Foreign
mortgage-backed securities generally are structured differently than domestic
mortgage-backed securities, but they normally present substantially similar
investment risks as well as the other risks normally associated with foreign
securities.
During 1994, the value and liquidity of many mortgage-backed securities
declined sharply due primarily to increases in interest rates. There can be no
assurance that such declines will not recur. The market value of certain
mortgage-backed securities, including IO and PO classes of mortgage-backed
securities, can be extremely volatile, and these securities may become illiquid.
Mitchell Hutchins or (for Low Duration Fund) the sub-adviser seeks to manage the
funds' investments in mortgage-backed securities so that the volatility of each
fund's portfolio, taken as a whole, is consistent with its investment objective.
Management of portfolio duration is an important part of this. However,
computing the duration of mortgage-backed securities is complex. See, "--
Duration." If Mitchell Hutchins or the sub-adviser does not compute the duration
of mortgage-backed securities correctly, the value of the fund's portfolio may
be either more or less sensitive to changes in market interest rates than
intended. In addition, if market interest rates or other factors that affect the
volatility of securities held by a fund change in ways that Mitchell Hutchins or
the sub-adviser does not anticipate, the fund's ability to meet its investment
objective may be reduced.
More information concerning these mortgage-backed securities and the
related risks of investments therein is set forth below. New types of
mortgage-backed securities are developed and marketed from time to time and,
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consistent with their investment limitations, the funds expect to invest in
those new types of mortgage-backed securities that Mitchell Hutchins or the
sub-adviser believe may assist the funds in achieving their investment
objectives. Similarly, the funds may invest in mortgage-backed securities issued
by new or existing governmental or private issuers other than those identified
herein. The funds that may invest in foreign securities may invest in foreign
mortgage-backed securities, which may be structured differently than domestic
mortgage-backed securities.
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. 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 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.
PRIVATE MORTGAGE-BACKED SECURITIES--Mortgage-backed securities issued by
Private Mortgage Lenders are structured similarly to 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.
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 the 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 accrued 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
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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
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amounts attributable to such classes, 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 class, 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.
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) loss protection. Loss protection
related to 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. Loss protection 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. A fund 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 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
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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
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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 was to assume that prepayments on pools of
fixed rate 30-year mortgages would result in a 12-year average life for the
pool. At present, mortgage pools, particularly those with loans with other
maturities or different characteristics, are priced on an assumption of average
life determined for each pool. In periods of declining interest rates, the rate
of prepayment tends to increase, thereby shortening the actual average life of a
pool of mortgage-related securities. Conversely, in periods of rising interest
rates, the rate of prepayment tends to decrease, thereby lengthening the actual
average life of the pool. However, these effects may not be present, or may
differ in degree, if the mortgage loans in the pools have adjustable interest
rates or other special payment terms, such as a prepayment charge. Actual
prepayment experience may cause the yield of mortgage-backed securities to
differ from the assumed average life yield. Reinvestment of prepayments may
occur at lower interest rates than the original investment, thus adversely
affecting a fund's yield.
ADJUSTABLE RATE MORTGAGE AND FLOATING RATE MORTGAGE-BACKED
SECURITIES--Adjustable rate mortgage ("ARM") securities are mortgage-backed
securities (sometimes referred to as "ARMs") 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.
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. ARMs represent a right to receive
interest payments at a rate that is adjusted to reflect the interest earned on a
pool of adjustable rate mortgage loans. These mortgage loans 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 adjustable rate mortgage loans specify limitations on the
maximum amount by which the mortgage interest rate may adjust for any single
adjustment period. These mortgage loans also may limit changes in the maximum
amount by which the borrower's monthly payment may adjust for any single
adjustment period. If a monthly payment is not sufficient to pay the interest
accruing on the adjustable rate mortgage, any such excess interest is added to
the mortgage loan ("negative amortization"), which is repaid through future
payments. If a 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 adjustable rate
mortgage loan. Borrowers under these mortgage loans experiencing negative
amortization may take longer to build up their equity in the underlying property
and may be more likely to default.
Adjustable rate mortgage loans 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 these mortgage loans 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 adjustable
rate mortgage loans might decrease. The rate of prepayments with respect to
adjustable rate mortgage loans has fluctuated in recent years.
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The rates of interest payable on certain adjustable rate mortgage loans,
and therefore on certain ARM 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 securities supported by adjustable rate
mortgage loans that adjust based on lagging indices tend to be somewhat more
sensitive to interest rate fluctuations than those reflecting current interest
rate levels, although the values of such ARM 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
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
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on monthly or other periodic changes in interest rates or monthly payments.
INVESTING IN FOREIGN SECURITIES. Investing in foreign securities involves
more risks than investing in the United States. The value of foreign securities
is subject to economic and political developments in the countries where the
companies operate and to changes in foreign currency values. Investments in
foreign securities 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 may include expropriation, confiscatory taxation, withholding taxes on
interest and/or dividends, limitations on the use of or transfer of fund assets
and 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
position. In those European countries that have begun using the Euro as a common
currency unit, individual national economies may be adversely affected by the
inability of national governments to use monetary policy to address their own
economic or political concerns.
Securities of many foreign companies may be less liquid and their prices
more volatile than securities of comparable U.S. companies. From time to time
foreign securities may be difficult to liquidate rapidly without significantly
depressing the price of such securities. Transactions in foreign securities may
be subject to less efficient settlement practices. Foreign securities trading
practices, including those involving securities settlement where fund assets may
be released prior to receipt of payment, may expose a fund to increased risk in
the event of a failed trade or the insolvency of a foreign broker-dealer. Legal
remedies for defaults and disputes may have to be pursued in foreign courts,
whose procedures differ substantially from those of U.S. courts. Additionally,
the costs of investing outside the United States frequently are higher than
those in the United States. These costs include relatively higher costs to
execute trades and foreign custody expenses.
Securities of foreign issuers may not be registered with the Securities
and Exchange Commission ("SEC"), and the issuers thereof may not be subject to
its reporting requirements. Accordingly, there may be less publicly available
information concerning foreign issuers of securities held by the 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.
FOREIGN CURRENCY RISKS. Currency risk is the risk that changes in foreign
exchange rates may reduce the U.S. dollar value of a fund's foreign investments.
If the value of a foreign currency rises against the value of the U.S. dollar,
the value of a fund's investments that are denominated in, or linked to, that
currency will increase. Conversely, if the value of a foreign currency declines
against the value of the U.S. dollar, the value of such fund investments will
decrease. Such changes may have a significant impact on the value of fund
shares. In some instances, a fund may use derivative strategies to hedge against
changes in foreign currency value. (See "Strategies Using Derivative
Instruments" below.) However, opportunities to hedge against currency risk may
not exist in certain markets, particularly with respect to emerging market
currencies, and even when appropriate hedging opportunities are available, a
fund may choose not to hedge against currency risk.
Generally, currency exchange rates are determined by supply and demand in
the foreign exchange markets and the relative merits of investments in different
countries. In the case of those European countries that use the Euro as a common
currency unit, the relative merits of investments in the common market in which
they participate, rather than the merits of investments in the individual
country, will be a determinant of currency exchange rates. Currency exchange
rates also can be affected by the intervention of the U.S. and foreign
governments or central banks, the imposition of currency controls, speculation,
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devaluation or other political or economic developments inside and outside the
United States.
Each fund values its assets daily in U.S. dollars and does not intend to
convert its holdings of foreign currencies to U.S. dollars on a daily basis.
From time to time a fund's foreign currencies may be held as "foreign currency
call accounts" at foreign branches of foreign or domestic banks. These accounts
bear interest at negotiated rates and are payable upon relatively short demand
periods. If a bank became insolvent, a fund could suffer a loss of some or all
of the amounts deposited. Each fund may convert foreign currency to U.S. dollars
from time to time.
The value of the assets of a fund as measured in U.S. dollars may be
affected favorably or unfavorably by fluctuations in currency rates and exchange
control regulations. Further, a fund may incur costs in connection with
conversions between various currencies. Currency exchange dealers realize a
profit based on the difference between the prices at which they are buying and
selling various currencies. Thus, a dealer normally will offer to sell a foreign
currency to a fund at one rate, while offering a lesser rate of exchange should
a fund desire immediately to resell that currency to the dealer. Each fund
conducts its currency exchange transactions either on a spot (i.e., cash) basis
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at the spot rate prevailing in the foreign currency exchange market, or through
entering into forward, futures or options contracts to purchase or sell foreign
currencies.
SPECIAL CHARACTERISTICS OF EMERGING MARKET SECURITIES AND SOVEREIGN DEBT
EMERGING MARKET INVESTMENTS. The special risks of investing in foreign
securities are heightened when emerging markets are involved. For example, many
emerging market currencies recently have experienced significant devaluations
relative to the U.S. dollar. Emerging market countries typically have economic
and political systems that are less fully developed and can be expected to be
less stable than those of developed countries. Emerging market countries may
have policies that restrict investment by foreigners, and there is a higher risk
of government expropriation or nationalization of private property. The
possibility of low or nonexistent trading volume in the securities of companies
in emerging markets also may result in a lack of liquidity and in price
volatility. Issuers in emerging markets typically are subject to a greater
degree of change in earnings and business prospects than are companies in
developed markets.
INVESTMENT AND REPATRIATION RESTRICTIONS. Foreign investment in the
securities markets of several emerging market countries is restricted or
controlled to varying degrees. These restrictions may limit a fund's investment
in these countries and may increase its expenses. For example, certain countries
may require governmental approval prior to investments by foreign persons in a
particular company or industry sector or limit investment by foreign persons to
only a specific class of securities of a company, which may have less
advantageous terms (including price) than securities of the company available
for purchase by nationals. Certain countries may restrict or prohibit investment
opportunities in issuers or industries deemed important to national interests.
In addition, the repatriation of both investment income and capital from some
emerging market countries is subject to restrictions, such as the need for
certain government consents. Even where there is no outright restriction on
repatriation of capital, the mechanics of repatriation may affect certain
aspects of a fund's operations. These restrictions may in the future make it
undesirable to invest in the countries to which they apply. In addition, if
there is a deterioration in a country's balance of payments or for other
reasons, a country may impose restrictions on foreign capital remittances
abroad. A fund could be adversely affected by delays in, or a refusal to grant,
any required governmental approval for repatriation, as well as by the
application to it of other restrictions on investments.
If, because of restrictions on repatriation or conversion, a fund were
unable to distribute substantially all of its net investment income and capital
gains within applicable time periods, the fund could be subject to federal
income and excise taxes that would not otherwise be incurred and could cease to
qualify for the favorable tax treatment afforded to regulated investment
companies under the Internal Revenue Code. In such case, it would become subject
to federal income tax on all of its net income and gains. To avoid these adverse
consequences, the fund might be required to distribute amounts that are greater
than the total amount of cash it actually receives. These distributions would
have to be made from the fund's cash assets or, if necessary, from the proceeds
of sales of portfolio securities. A fund would not be able to purchase
additional securities with cash used to make such distributions, and its current
income and the value of its shares might ultimately be reduced as a result.
SOCIAL, POLITICAL AND ECONOMIC FACTORS. Many emerging market countries may
be subject to a greater degree of social, political and economic instability
than is the case in the United States. Any change in the leadership or policies
of these countries may halt the expansion of or reverse any liberalization of
foreign investment policies now occurring. Such instability may result from,
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among other things, the following: (i) authoritarian governments or military
involvement in political and economic decision making, and changes in government
through extra-constitutional means; (ii) popular unrest associated with demands
for improved political, economic and social conditions; (iii) internal
insurgencies; (iv) hostile relations with neighboring countries; and (v) ethnic,
religious and racial disaffection. Such social, political and economic
instability could significantly disrupt the financial markets in those countries
and elsewhere and could adversely affect the value of a fund's assets. In
addition, there may be the possibility of asset expropriations or future
confiscatory levels of taxation affecting a fund.
The economies of many emerging markets are heavily dependent upon
international trade and are accordingly affected by protective trade barriers
and the economic conditions of their trading partners, principally the United
States, Japan, China and the European Union. The enactment by the United States
or other principal trading partners of protectionist trade legislation,
reduction of foreign investment in the local economies and general declines in
the international securities markets could have a significant adverse effect
upon the securities markets of these countries. In addition, the economies of
some countries are vulnerable to weakness in world prices for their commodity
exports.
FINANCIAL INFORMATION AND LEGAL STANDARDS. Issuers in emerging market
countries generally are subject to accounting, auditing and financial standards
and requirements that differ, in some cases significantly, from those applicable
to U.S. issuers. In particular, the assets and profits appearing on the
financial statements of an emerging market issuer may not reflect its financial
position or results of operations in the way they would be reflected had the
financial statements been prepared in accordance with U.S. generally accepted
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accounting principles. In addition, for an issuer that keeps accounting records
in local currency, inflation accounting rules may require, for both tax and
accounting purposes, that certain assets and liabilities be restated on the
issuer's balance sheet in order to express items in terms of currency of
constant purchasing power. Inflation accounting may indirectly generate losses
or profits. Consequently, financial data may be materially affected by
restatements for inflation and may not accurately reflect the real condition of
those issuers and securities markets.
In addition, existing laws and regulations are often inconsistently
applied. As legal systems in some of the emerging market countries develop,
foreign investors may be adversely affected by new laws and regulations, changes
to existing laws and regulations and preemption of local laws and regulations by
national laws. In circumstances where adequate laws exist, it may not be
possible to obtain swift and equitable enforcement of the law.
FOREIGN SOVEREIGN DEBT. Sovereign debt includes bonds that are issued by
foreign governments or their agencies, instrumentalities or political
subdivisions or by foreign central banks. Sovereign debt also may be issued by
quasi-governmental entities that are owned by foreign governments but are not
backed by their full faith and credit or general taxing powers. Investment in
sovereign debt involves special risks. The issuer of the debt or the
governmental authorities that control the repayment of the debt may be unable or
unwilling to repay principal and/or interest when due in accordance with the
terms of such debt, and the funds may have limited legal recourse in the event
of a default.
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 somewhat diminished. 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 debt issued by 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 repay principal and/or to
pay interest due 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 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.
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The occurrence of political, social or diplomatic changes in one or more
of the countries issuing sovereign debt could adversely affect the funds'
investments. Political changes or a deterioration of a country's domestic
economy or balance of trade may affect the willingness of countries to service
their sovereign debt. While the funds' portfolios are managed in a manner that
is intended to minimize the exposure to such risks, there can be no assurance
that adverse political changes will not cause a fund to suffer a loss of
interest or principal on any of its sovereign debt holdings.
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. Some emerging market
countries have from time to time declared moratoria on the payment of principal
and interest on external debt.
Some 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.
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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 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 International Monetary Fund, ("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 Bonds have been issued only in recent years, 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 which the price and yield to the investor reflect market conditions at
the time of purchase.
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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 until the
scheduled maturity 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 that would have then been due on the Brady Bonds in the
normal course. Interest payments on Brady Bonds may be wholly uncollateralized
or 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.
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,
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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.
CURRENCY-LINKED INVESTMENTS. The principal amount of securities that are
indexed to specific foreign currency exchange rates may be adjusted up or down
(but not below zero) at maturity to reflect changes in the exchange rate between
currencies. A fund may experience loss of principal due to these adjustments.
ZERO COUPON AND OTHER OID SECURITIES; PIK SECURITIES. Zero coupon
securities are securities on which no periodic interest payments are made but
instead are sold at a deep discount from their face value. The buyer of these
securities receives a rate of return by the gradual appreciation of the
security, which results from the fact that it will be paid at face value on a
specified maturity date. There are many types of zero coupon securities. Some
are issued in zero coupon form, including Treasury bills, notes and bonds that
have been stripped of (separated from) their unmatured interest coupons
(unmatured interest payments) and receipts or certificates representing
interests in such stripped debt obligations and coupons. Others are created by
brokerage firms that strip the coupons from interest-paying debt securities and
sell the principal and the coupons separately.
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The funds may invest in other securities with original issue discount
("OID"), a term that means the securities issued at a price that is lower than
their value at maturity, even though the securities also may make cash payments
of interest prior to maturity. In addition, payment-in-kind ("PIK") securities
pay interest in additional securities, not in cash. OID and PIK securities
usually trade at a discount from their face value.
Zero coupon securities are generally more sensitive to changes in interest
rates than debt obligations of comparable maturities that make current interest
payments. This means that when interest rates fall, the value of zero coupon
securities rises more rapidly than securities paying interest on a current
basis. However, when interest rates rise, their value falls more dramatically.
Other OID securities and PIK securities also are subject to greater fluctuations
in market value in response to changing interest rates than debt securities of
comparable maturities that make current distributions of interest in cash.
Federal tax law requires that the holder of a zero coupon or other OID
security include in gross income each year the OID that accrues on the security
for the year, even though the holder receives no interest payment on the
security during the year. Similarly, while PIK securities may pay interest in
the form of additional securities rather than cash, that interest must be
included in a fund's current income. These distributions would have to be made
from the fund's cash assets or, if necessary, from the proceeds of sales of
portfolio securities. A fund would not be able to purchase additional securities
with cash used to make such distributions, and its current income and the value
of its shares would ultimately be reduced as a result.
Certain zero coupon securities are U.S. Treasury notes and bonds that have
been stripped of their unmatured coupons 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 Fund.
CONVERTIBLE SECURITIES. A convertible security is a bond, 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 or dividends until the convertible security
matures or is redeemed, converted or exchanged. Convertible securities have
unique investment characteristics in that they generally (1) have higher yields
than common stocks, but lower yields than comparable non-convertible securities,
(2) are less subject to fluctuation in value than the underlying stock because
they have fixed income characteristics and (3) provide the potential for capital
appreciation if the market price of the underlying common stock increases. While
no securities investment is without some risk, investments in convertible
securities generally entail less risk than the issuer's common stock. However,
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.
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Before conversion, convertible securities have characteristics similar to
non-convertible 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
non-convertible securities. 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. Generally, the conversion value decreases as the convertible security
approaches maturity. To the extent the market price of the underlying common
stock approaches or exceeds the conversion price, the price of the convertible
security will be increasingly influenced by its conversion value. In addition, a
convertible security generally will sell at a premium over its conversion value
determined by the extent to which investors place value on the right to acquire
the underlying common stock while holding a fixed income security.
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,
the fund will be required to permit the issuer to redeem the security, convert
it into the underlying common stock or sell it to a third party. 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.
LOAN PARTICIPATIONS AND ASSIGNMENTS. Investments in secured or unsecured
fixed or floating rate loans ("Loans") arranged through private negotiations
between a borrowing corporation, government or other entity and one or more
financial institutions ("Lenders") may be in the form of participations
("Participations") in Loans or assignments ("Assignments") of all or a portion
of Loans from third parties. Participations typically result in the 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 a 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 selling Lender, the fund may be treated as a general
creditor of that Lender and may not benefit from any set-off between the Lender
and the borrower. A fund will acquire Participations only if Mitchell Hutchins
determines that the selling Lender is creditworthy.
When a fund purchases Assignments from Lenders, it acquires direct rights
against the borrower on the Loan. In an Assignment, the fund is entitled to
receive payments directly from the borrower and, therefore, does not depend on
the selling bank to pass these payments onto the fund. However, because
Assignments are arranged through private negotiations between potential
assignees and assignors, the rights and obligations acquired by the fund as the
purchaser of an Assignment may differ from, and be more limited than, those held
by the assigning Lender.
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Assignments and Participations are generally not registered under the
Securities Act of 1933, as amended ("Securities Act of 1933"), and thus may be
subject to a fund's limitation on investment in illiquid securities. Because
there may be no liquid market for such securities, such securities may be sold
only to a limited number of institutional investors. The lack of a liquid
secondary market could 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.
TEMPORARY AND DEFENSIVE INVESTMENTS; MONEY MARKET INVESTMENTS. Each fund
may invest in money market investments for temporary or defensive purposes or as
part of its normal investment program. Such investments include, among other
things, (1) securities issued or guaranteed by the U.S. government or one of its
agencies or instrumentalities, (2) commercial paper rated at least A-1 by S&P or
P-1 by Moody's (Low Duration Fund and Investment Grade Income Fund) or without
regard to rating (High Income Fund and Strategic Income Fund), (3) bank
certificates of deposit, bankers' acceptances and (4) repurchase agreements
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 or repurchase agreements secured by such obligations.
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WARRANTS. Warrants are securities permitting, but not obligating, holders
to subscribe for other securities. Warrants do not carry with them the right to
dividends or voting rights with respect to the securities that they entitle
their holder to purchase, and they do not represent any rights in the assets of
the issuer. As a result, warrants may be considered more speculative than
certain other types of investments. In addition, the value of a warrant does not
necessarily change with the value of the underlying securities, and a warrant
ceases to have value if it is not exercised prior to its expiration date.
ILLIQUID SECURITIES. The term "illiquid securities" for purposes of the
Prospectus and Statement of Additional Information 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 options, repurchase agreements
maturing in more than seven days and restricted securities other than those
Mitchell Hutchins or (for Low Duration Fund) the sub-adviser has determined are
liquid pursuant to guidelines established by each fund's board. The assets used
as cover for over-the-counter options written by the funds will be considered
illiquid unless the over-the-counter options are sold to qualified dealers who
agree that the funds may repurchase any over-the-counter options they write at a
maximum price to be calculated by a formula set forth in the option agreements.
The cover for an over-the-counter 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, IO and PO classes of mortgage-backed securities generally 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 the
sub-adviser has determined that they are liquid pursuant to guidelines
established by each fund's board. To the extent a fund invests in illiquid
securities, it may not be able to readily liquidate such investments and may
have to sell other investments if necessary to raise cash to meet its
obligations. The lack of a liquid secondary market for illiquid securities may
make it more difficult for a fund to assign a value to those securities for
purposes of valuing its portfolio and calculating its net asset value.
Restricted securities are not registered under the Securities Act of 1933
and may be sold only in privately negotiated or other exempted transactions or
after a registration statement under the Securities Act of 1933 has become
effective. 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 a fund may be permitted to sell a
security under an effective registration statement. If, during such a period,
adverse market conditions were to develop, a fund might obtain a less favorable
price than prevailed when it decided to sell.
However, not all restricted securities are illiquid. To the extent that
foreign securities are freely tradeable in the country in which they are
principally traded, they generally are not considered illiquid, even if they are
restricted in the United States. A large institutional market has developed for
many U.S. and foreign securities that are not registered under the Securities
Act of 1933. 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.
Institutional markets for restricted securities also have developed as a
result of Rule 144A, which establishes a "safe harbor" from the registration
requirements of the Securities Act of 1933 for resales of certain securities to
qualified institutional buyers. Such markets include automated systems for the
trading, clearance and settlement of unregistered securities of domestic and
foreign issuers, such as the PORTAL System sponsored by the National Association
of Securities Dealers, Inc. An insufficient number of qualified institutional
buyers interested in purchasing Rule 144A-eligible restricted securities held by
a fund, however, could affect adversely the marketability of such portfolio
securities, and the fund might be unable to dispose of such securities promptly
or at favorable prices.
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Each board has delegated the function of making day-to-day determinations
of liquidity to Mitchell Hutchins or the sub-adviser, as applicable, pursuant to
guidelines approved by the board. Mitchell Hutchins or the sub-adviser takes
into account a number of factors in reaching liquidity decisions, including (1)
the frequency of trades for the security, (2) the number of dealers that make
quotes for the security, (3) the number of dealers that have undertaken to make
a market in the security, (4) the number of other potential 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 the sub-adviser monitors the liquidity of restricted
securities in each fund's portfolio and reports periodically on such decisions
to the applicable board.
REPURCHASE AGREEMENTS. Repurchase agreements are transactions in which a
fund purchases securities or other obligations from a bank or securities dealer
(or its affiliate) and simultaneously commits to resell them to the counterparty
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 obligations.
A fund maintains custody of the underlying obligations prior to their
repurchase, either through its regular custodian or through a special
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"tri-party" custodian or sub-custodian that maintains separate accounts for both
the fund and its counterparty. Thus, the obligation of the counterparty to pay
the repurchase price on the date agreed to or upon demand is, in effect, secured
by such obligations. Repurchase agreements carry certain risks not associated
with direct investments in securities, including a possible decline in the
market value of the underlying obligations. If their value becomes less than the
repurchase price, plus any agreed-upon additional amount, the counterparty 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
obligations and the price that was paid by a fund upon acquisition is accrued as
interest and included in its net investment income. Repurchase agreements
involving obligations other than U.S. government securities (such as commercial
paper and corporate bonds) may be subject to special risks and may not have the
benefit of certain protections in the event of the counterparty's insolvency. If
the seller or guarantor becomes insolvent, the fund may suffer delays, costs and
possible losses in connection with the disposition of collateral. Each fund
intends to enter into repurchase agreements only with counterparties in
transactions believed by Mitchell Hutchins or the sub-adviser to present minimum
credit risks in accordance with guidelines established by the fund's board.
REVERSE REPURCHASE AGREEMENTS. Reverse repurchase agreements involve the
sale of securities held by a fund subject to its agreement to repurchase the
securities at an agreed-upon date or upon demand and at a price reflecting a
market rate of interest. Reverse repurchase agreements are subject to each
fund's limitation on borrowings and may be entered into only with banks and
securities dealers. While a reverse repurchase agreement is outstanding, a fund
will maintain, in a segregated account with its custodian, cash or liquid
securities, marked to market daily, in an amount at least equal to its
obligations under the reverse repurchase agreement.
Reverse repurchase agreements involve the risk that the buyer of the
securities sold by a fund might be unable to deliver them when that fund seeks
to repurchase. If the buyer of securities under a reverse repurchase agreement
files for bankruptcy or becomes insolvent, such buyer or trustee or receiver may
receive an extension of time to determine whether to enforce that fund's
obligation to repurchase the securities, and the fund's use of the proceeds of
the reverse repurchase agreement may effectively be restricted pending such
decision.
DOLLAR ROLLS. In a dollar roll, a fund sells mortgage-backed or other
securities for delivery on the next regular settlement date for those securities
and, simultaneously, contracts to purchase substantially similar securities for
delivery on a later settlement date. Dollar rolls also are subject to a fund's
limitation on borrowings.
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. Each fund may purchase
securities on a "when-issued" basis or may purchase or sell securities for
delayed delivery, i.e., for issuance or delivery to or by the fund later than
the normal settlement date for such securities at a stated price and yield.
When-issued securities include TBA ("to be assigned") securities. TBA securities
are usually mortgage-backed securities that are purchased on a forward
commitment basis with an approximate principal amount and no defined maturity
date. The actual principal amount and maturity date are determined upon
settlement when the specific mortgage pools are assigned. A fund generally would
not pay for such securities or start earning interest on them until they are
received. However, when a fund undertakes a when-issued or delayed delivery
obligation, it immediately assumes the risks of ownership, including the risks
of price fluctuation. Failure of the issuer to deliver a security purchased by a
fund on a when-issued or delayed delivery basis may result in the fund's
incurring or missing an opportunity to make an alternative investment. Depending
on market conditions, a fund's when-issued and delayed delivery purchase
commitments could cause its net asset value per share to be more volatile,
because such securities may increase the amount by which the fund's total
assets, including the value of when-issued and delayed delivery securities held
by that fund, exceeds its net assets.
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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 commits to purchase securities
on a when-issued or delayed delivery basis, its custodian segregates assets to
cover the amount of the commitment. See "The Funds' Investments, Related risks
and Limitations--Segregated Accounts." A fund may sell the right to acquire the
security prior to delivery if Mitchell Hutchins or the sub-adviser, as
applicable, deems it advantageous to do so, which may result in a gain or loss
to the fund.
DURATION. Duration is a measure of the expected life of a debt security on
a present value basis. Duration incorporates the debt security's yield, coupon
interest payments, final maturity and call features into one measure and is one
of the fundamental tools used by Mitchell Hutchins and (for Low Duration Fund)
the sub-adviser in portfolio selection and yield curve positioning for a fund's
bond investments. Duration 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
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security provides for a final payment, taking no account of the pattern of the
security's payments prior to maturity.
Duration takes the length of the time intervals between the present time
and the time that the interest and principal payments are scheduled or, in the
case of a callable debt security, expected to be made, and weights them by the
present values of the cash to be received at each future point in time. For any
debt security with interest payments occurring prior to the payment of
principal, duration is always less than maturity. For example, depending on 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.
Duration allows Mitchell Hutchins and the sub-adviser to make certain
predictions as to the effect that changes in the level of interest rates will
have on the value of a fund's portfolio of debt securities. For example, when
the level of interest rates increases by 1%, a debt security having a positive
duration of three years generally will decrease by approximately 3%. Thus, if
Mitchell Hutchins or the sub-adviser calculates the duration of a fund's
portfolio of debt securities as three years, it normally would expect the
portfolio to change in value by approximately 3% for every 1% change in the
level of interest rates. However, various factors, such as changes in
anticipated prepayment rates, qualitative considerations and market supply and
demand, can cause particular securities to respond somewhat differently to
changes in interest rates than indicated in the above example. Moreover, in the
case of mortgage-backed and other complex securities, duration calculations are
estimates and are not precise. This is particularly true during periods of
market volatility. Accordingly, the net asset value of a fund's portfolio of
debt securities may vary in relation to interest rates by a greater or lesser
percentage than indicated by the above example.
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 will lengthen portfolio 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 the sub-adviser 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.
LENDING OF PORTFOLIO SECURITIES. Each fund is authorized to lend its
portfolio securities to broker-dealers or institutional investors that Mitchell
Hutchins deems qualified. Lending securities enables a fund to earn additional
income, but could result in a loss or delay in recovering these securities. The
borrower of a fund's portfolio securities must maintain acceptable collateral
with that 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. Each fund may reinvest any cash collateral in money market
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investments or other short-term liquid investments. 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 of its loans at any
time. Each fund may pay fees in connection with a loan and may pay the borrower
or placing broker a negotiated portion of the interest earned on the
reinvestment of cash held as collateral. A fund will receive amounts equivalent
to any dividends, interest or other distributions on the securities loaned. Each
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.
Pursuant to procedures adopted by the boards governing each fund's
securities lending program, PaineWebber has been retained to serve as lending
agent for each fund. The boards also have authorized the payment of fees
(including fees calculated as a percentage of invested cash collateral) to
PaineWebber for these services. Each board periodically reviews all portfolio
securities loan transactions for which PaineWebber acted as lending agent.
PaineWebber also has been approved as a borrower under each fund's securities
lending program.
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SHORT SALES "AGAINST THE BOX." Each fund may engage in short sales of
securities it owns or has the right to acquire at no added cost through
conversion or exchange of other securities it owns (short sales "against the
box"). To make delivery to the purchaser in a short sale, the executing broker
borrows the securities being sold short on behalf of a fund, and that fund is
obligated to replace the securities borrowed at a date in the future. When a
fund sells short, it establishes a margin account with the broker effecting the
short sale and deposits collateral with the broker. In addition, the fund
maintains, in a segregated account with its custodian, the securities that could
be used to cover the short sale. Each fund incurs transaction costs, including
interest expense, in connection with opening, maintaining and closing short
sales "against the box."
A fund might make a short sale "against the box" to hedge against market
risks when Mitchell Hutchins or (for Low Duration Fund) the sub-adviser believes
that the price of a security may decline, thereby causing a decline in the value
of a security owned by the fund or a security convertible into or exchangeable
for a security owned by the fund. In such case, any loss in the fund's long
position after the short sale should be reduced by a corresponding gain in the
short position. Conversely, any gain in the long position after the short sale
should be reduced by a corresponding loss in the short position. The extent to
which gains or losses in the long position are reduced will depend upon the
amount of the securities sold short relative to the amount of the securities a
fund owns, either directly or indirectly, and in the case where the fund owns
convertible securities, changes in the investment values or conversion premiums
of such securities.
SEGREGATED ACCOUNTS. When a fund enters into certain transactions that
involve obligations to make future payments to third parties, including the
purchase of securities on a when-issued or delayed delivery basis or reverse
repurchase agreements, it 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 "Strategies Using Derivative
Instruments," segregated accounts may also be required in connection with
certain transactions involving options, futures, forward currency contracts and
swaps.
INVESTMENT LIMITATIONS OF THE FUNDS
FUNDAMENTAL LIMITATIONS. The following fundamental investment limitations
cannot be changed for a fund without the affirmative vote of the lesser of (a)
more than 50% of the outstanding shares of the fund or (b) 67% or more of the
shares of the fund present at a shareholders' meeting if more than 50% of the
outstanding shares are represented at the meeting in person or by proxy. If a
percentage restriction is adhered to at the time of an investment or
transaction, later changes in percentage resulting from a change in values of
portfolio securities or amount of total assets will not be considered a
violation of any of the following limitations.
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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 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, as amended ("Investment Company Act of 1940")
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.
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(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 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 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 are
non-fundamental and may be changed by the vote of the appropriate board without
shareholder approval.
Each fund will not:
(1) invest more than 10% of its net assets (15% of net assets for Low
Duration Fund and Strategic Income Fund) in illiquid securities.
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(2) purchase portfolio securities while borrowings in excess of 5% of its
total assets are outstanding.
(3) 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.
(4) 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.
(5) purchase securities of other investment companies, except to the
extent permitted by the Investment Company Act of 1940 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 (and except that a fund will not purchase securities of registered
open-end investment companies or registered unit investment trusts in reliance
on Sections 12(d)(1)(F) or 12(d)(1)(G) of the Investment Company Act of 1940).
STRATEGIES USING DERIVATIVE INSTRUMENTS
GENERAL DESCRIPTION OF DERIVATIVE INSTRUMENTS. Mitchell Hutchins and (for
Low Duration Fund) the sub-adviser 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 each fund's portfolio and also to attempt to enhance income,
realize gains or manage the duration of its portfolio. Each fund also may enter
into interest rate swap transactions. High Income Fund and Strategic Income Fund
also may use forward currency contracts for hedging purposes. A fund may enter
into transactions involving one or more types of Derivative Instruments under
which the full value of its portfolio is at risk. Under normal circumstances,
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however, each fund's use of these instruments will place at risk a much smaller
portion of its assets. In particular, each fund may use the Derivative
Instruments described below.
The funds might not use any derivative instruments or strategies, and
there can be no assurance that using any strategy will succeed. If the Mitchell
Hutchins or the sub-adviser, as applicable, is incorrect in its judgment on
market values, interest rates or other economic factors in using a derivative
instrument or strategy, a fund may have lower net income and a net loss on the
investment.
OPTIONS ON 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 or at specified
times or at the expiration of the option, depending on the type of option
involved. 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 that 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 or at specified times or at the expiration of the option,
depending on the type of option involved. 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 SECURITIES INDICES--A securities index assigns relative values
to the securities included in the index and fluctuates with changes in the
market values of those securities. A securities index option operates in the
same way as a more traditional securities option, except that exercise of a
securities index option is effected with cash payment and does not involve
delivery of securities. Thus, upon exercise of a securities 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 securities
index.
SECURITIES INDEX FUTURES CONTRACTS--A securities 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 securities 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 AND FOREIGN CURRENCY FUTURES CONTRACTS--Interest rate and
foreign currency futures contracts are bilateral agreements pursuant to which
one party agrees to make, and the other party agrees to accept, delivery of a
specified type of debt security or currency at a specified future time and at a
specified price. Although such futures contracts by their terms call for actual
delivery or acceptance of debt securities or currency, in most cases the
contracts are closed out before the settlement date without the making or taking
of delivery.
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OPTIONS ON FUTURES CONTRACTS--Options on futures contracts are similar to
options on securities or currency, except that an option on a futures contract
gives the purchaser the right, in return for the premium, 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 or
currency, at a specified price at any time during the option term or at
specified times or at the expiration of the option, depending on the type of
option involved. 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.
GENERAL DESCRIPTION OF STRATEGIES USING DERIVATIVE INSTRUMENTS. 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
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that security. If the price of the security declined below the exercise price of
the put, a fund could exercise the put and thus limit its loss below the
exercise price to the premium paid plus transaction costs. In the alternative,
because the value of the put option can be expected to increase as the value of
the underlying security declines, a 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, a fund could exercise the call and thus limit its acquisition
cost to the exercise price plus the premium paid and transaction costs.
Alternatively, a fund might be able to offset the price increase by closing out
an appreciated call option and realizing a gain.
A fund may purchase and write (sell) straddles on securities or indices of
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 the sub-adviser
believes it likely that the prices of the securities 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 the sub-adviser
believes it unlikely that the prices of the securities 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 stock indices, in contrast,
generally are used to hedge against price movements in broad equity market
sectors in which a fund has invested or expects to invest. Derivative
Instruments on debt securities may be used to hedge either individual securities
or broad fixed income market sectors.
Income strategies using Derivative Instruments may include the writing of
covered options to obtain the related option premiums. Gain strategies may
include using Derivative Instruments to increase or decrease a fund's exposure
to different asset classes without buying or selling the underlying instruments.
A fund also may use derivatives to simulate full investment by the fund while
maintaining a cash balance for fund management purposes (such as to provide
liquidity to meet anticipated shareholder sales of fund shares and for fund
operating expenses).
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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 may be limited by tax considerations. See
"Taxes."
In addition to the products, strategies and risks described below and in
the Prospectus, Mitchell Hutchins and the sub-adviser may discover additional
opportunities in connection with Derivative Instruments and with hedging, income
and gain strategies. These new opportunities may become available as regulatory
authorities broaden the range of permitted transactions and as new Derivative
Instruments and techniques are developed. Mitchell Hutchins or the sub-adviser
may utilize these opportunities for a fund to the extent that they are
consistent with the fund's investment objective and permitted by its 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 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 the ability
of Mitchell Hutchins or the sub-adviser to predict movements of the overall
securities, interest rate or currency exchange markets, which requires different
skills than predicting changes in the prices of individual securities. While
Mitchell Hutchins and the sub-adviser are experienced in the use of Derivative
Instruments, there can be no assurance that any particular 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 that are 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 affecting the markets in which Derivative
Instruments are traded, rather than the value of the investments being hedged.
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The effectiveness of hedges using Derivative Instruments on indices will depend
on the degree of correlation between price movements in the index and price
movements in the securities being hedged.
(3) Hedging strategies, if successful, can reduce risk of loss by wholly
or partially offsetting the negative effect of unfavorable price movements in
the investments being hedged. However, hedging strategies can also reduce
opportunity for gain by offsetting the positive effect of favorable price
movements in the hedged investments. For example, if a fund entered into a short
hedge because Mitchell Hutchins or the sub-adviser projected a decline in the
price of a security in that 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 the fund was
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 positions expired or matured. These requirements might impair a fund's
ability to sell a portfolio security or make an investment at a time when it
would otherwise be favorable to do so, or require that the fund sell a portfolio
security at a disadvantageous time. A fund's ability to close out a position in
a 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 counterparty to enter into a transaction closing out the
position. Therefore, there is no assurance that any hedging position can be
closed out at a time and price that is favorable to a fund.
COVER FOR STRATEGIES USING DERIVATIVE INSTRUMENTS. Transactions using
Derivative Instruments, other than purchased options, expose the funds 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 or other options or futures contracts or (2) cash or 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 such 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, committing a large portion of a
fund's assets to cover positions or to segregated accounts could impede
portfolio management or the fund's ability to meet redemption requests or other
current obligations.
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OPTIONS. The funds may purchase put and call options, and write (sell)
covered put or call options on securities in which they invest and related
indices and (for High Income Fund and Strategic Income Fund) on foreign
currencies. The purchase of call options may serve as a long hedge, and the
purchase of put options may serve as a short hedge. A fund may also use options
to attempt to realize gains by increasing or reducing its exposure to an asset
class without purchasing or selling the underlying securities. 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. Writing covered call options
serves as a limited short hedge, because declines in the value of the hedged
investment would be offset to the extent of the premium received for writing the
option. However, if the security appreciates to a price higher than the exercise
price of the call option, it can be expected that the option will be exercised
and the affected fund will be obligated to sell the security at less than its
market value. 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 security
depreciates to a price lower than the exercise price of the put option, it can
be expected that the put option will be exercised and the fund will be obligated
to purchase the security at more than its market value. The securities or other
assets used as cover for over-the-counter options written by a fund would be
considered illiquid to the extent described under "The Funds' Investments,
Related Risks and Limitations--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, over-the-counter options on bonds are
European-style options. This means that the option can only be exercised
immediately prior to its expiration. This is in contract to American-style
options that may be exercised at any time. There are also other types of options
that may be exercised on certain specified dates before expiration. Options that
expire unexercised have no value.
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A fund may effectively terminate its right or obligation under an option
by entering into a closing transaction. For example, a fund may terminate its
obligation under a call or put option that it had written by purchasing an
identical call or put option; this is known as a closing purchase transaction.
Conversely, a fund may terminate a position in a put or call option it had
purchased by writing an identical put or call option; this is known as a closing
sale transaction. Closing transactions permit a fund to realize profits or limit
losses on an option position prior to its exercise or expiration.
The funds may purchase and write both exchange-traded and over-the-counter
options. Exchange markets for options on debt securities and foreign currencies
exist but are relatively new, and these instruments are primarily traded on the
over-the-counter 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, over-the-counter options are contracts between a fund
and its counterparty (usually a securities dealer or a bank) with no clearing
organization guarantee. Thus, when a fund purchases or writes an
over-the-counter option, it relies on the counterparty to make or take delivery
of the underlying investment upon exercise of the option. Failure by the
counterparty to do so would result in the loss of any premium paid by the fund
as well as the loss of any expected benefit of the transaction.
The funds' ability to establish and close out positions in exchange-listed
options depends on the existence of a liquid market. The funds intend 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
over-the-counter options only by negotiating directly with the counterparty, or
by a transaction in the secondary market if any such market exists. Although the
funds will enter into over-the-counter options only with counterparties that are
expected to be capable of entering into closing transactions with the funds,
there is no assurance that a fund will in fact be able to close out an
over-the-counter option position at a favorable price prior to expiration. In
the event of insolvency of the counterparty, a fund might be unable to close out
an over-the-counter 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 put or call
option written by the fund could cause material losses because the fund would be
unable to sell the investment used as cover for the written option until the
option expires or is exercised.
A fund may purchase and write put and call options on indices 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 a securities market
(or market sector) rather than anticipated increases or decreases in the value
of a particular security.
LIMITATIONS ON THE USE OF OPTIONS. The use of options is governed by the
following guidelines, which can be changed by each fund's board without
shareholder vote:
(1) A fund may purchase a put or call option, including any straddle or
spread, only if the value of its premium, when aggregated with the premiums on
all other options held by the fund, does not exceed 5% of its total assets.
(2) The aggregate value of securities underlying put options written by a
fund, determined as of the date the put options are written, will not exceed 50%
of its net assets.
(3) The aggregate premiums paid on all options (including options on
securities, foreign currencies and securities indices and options on futures
contracts) purchased by a fund that are held at any time will not exceed 20% of
its net assets.
FUTURES. The funds may purchase and sell securities index futures
contracts and interest rate futures contracts. High Income Fund and Strategic
Income Fund also may purchase and sell foreign currency futures contracts. A
fund may purchase put and call options, and write covered put and call options,
on futures in which it is allowed to invest. The purchase of futures or call
options thereon can serve as a long hedge, and the sale of futures or the
purchase of put options thereon can serve as a short hedge. Writing covered call
options on futures contracts can serve as a limited short hedge, 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 options on securities
or indices. In addition, a fund may purchase or sell futures contracts or
purchase options thereon to increase or reduce its exposure to an asset class
without purchasing or selling the underlying securities.
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Futures strategies also can be used to manage the average duration of a
fund's portfolio. If Mitchell Hutchins or (for Low Duration Fund) the
sub-adviser wishes to shorten the average duration of a fund's portfolio, the
fund may sell a futures contract or a call option thereon, or purchase a put
option on that futures contract. If Mitchell Hutchins or the sub-adviser wishes
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to lengthen the average duration of the fund's portfolio, the fund may buy a
futures contract or a call option thereon, or sell a put option thereon.
A fund may also write put options on 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 a fund than is purchasing the
futures contract.
No price is paid upon entering into a futures contract. Instead, at the
inception of a futures contract a fund is required to deposit in a segregated
account with its custodian, in the name of the futures broker through whom the
transaction was effected, "initial margin" consisting of cash, 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 a fund at the termination of the transaction if all
contractual obligations have been satisfied. Under certain circumstances, such
as periods of high volatility, a fund may be required by an exchange to increase
the level of its initial margin payment, and initial margin requirements might
be increased generally in the future by regulatory action.
Subsequent "variation margin" payments are made to and from the futures
broker daily as the value of the futures position varies, a process known as
"marking to market." Variation margin does not involve borrowing, but rather
represents a daily settlement of each fund's obligations to or from a futures
broker. When a fund purchases an option on a future, the premium paid plus
transaction costs is all that is at risk. In contrast, when a fund purchases or
sells a futures contract or writes a call option thereon, it is subject to daily
variation margin calls that could be substantial in the event of adverse price
movements. If a fund has insufficient cash to meet daily variation margin
requirements, it might need to sell securities at a time when such sales are
disadvantageous.
Holders and writers of futures positions and options on futures can enter
into offsetting closing transactions, similar to closing transactions on
options, by selling or purchasing, respectively, an instrument identical to the
instrument held or written. Positions in futures and options on futures may be
closed only on an exchange or board of trade that provides a secondary market.
The funds intend 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 related options position
due to the absence of a liquid secondary market or the imposition of price
limits, it could incur substantial losses. A fund would continue to be subject
to market risk with respect to the position. In addition, except in the case of
purchased options, a 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.
26
<PAGE>
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.
26a
<PAGE>
LIMITATIONS ON THE USE OF FUTURES AND RELATED OPTIONS. The use of futures
and related options is governed by the following guidelines, which can be
changed by a fund's board without shareholder vote:
(1) To the extent a fund enters into futures contracts and options on
futures positions that are not for bona fide hedging purposes (as defined by the
CFTC), the aggregate initial margin and premiums on those positions (excluding
the amount by which options are "in-the-money") may not exceed 5% of its net
assets.
(2) The aggregate premiums paid on all options (including options on
securities, foreign currencies and securities indices and options on futures
contracts) purchased by each fund that are held at any time will not exceed 20%
of its net assets.
(3) The aggregate margin deposits on all futures contracts and options
thereon held at any time by each fund will not exceed 5% of its total assets.
FOREIGN CURRENCY HEDGING STRATEGIES--SPECIAL CONSIDERATIONS. High Income
Fund and Strategic Income Fund may use options and futures on foreign
currencies, as described above, and forward currency contracts, as described
below, to hedge against movements in the values of the foreign currencies in
which the fund's securities are denominated. Such currency hedges can protect
against price movements in a security 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 considered expensive. In such cases, the 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. In addition, a fund may use forward
currency contracts to shift exposure to foreign currency fluctuations from one
country to another. For example, if a 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 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.
27
<PAGE>
Settlement of Derivative Instruments involving foreign currencies might be
required to take place within the country issuing the underlying currency. Thus,
the funds 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 purchase a forward currency
contract to lock in the U.S. dollar price of a security denominated in a foreign
currency that the fund intends to acquire. Forward currency contract
transactions may also serve as short hedges--for example, 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.
27a
<PAGE>
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 a fund enters into a forward currency contract, it relies on the
counterparty to make or take delivery of the underlying currency at the maturity
of the contract. Failure by the counterparty 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 counterparty. Thus, there can be no assurance
that a 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 counterparty, a 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 foreign
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 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
segregates with its custodian cash or liquid securities in an amount not less
than the value of its total assets committed to the consummation of the contract
and not covered as provided in (1) above, as marked to market daily.
SWAP TRANSACTIONS. Swap transactions include swaps, caps, floors and
collars. Interest rate swaps involve an agreement between two parties to
exchange payments that are based, for example, on variable and fixed rates of
interest and that are calculated on the basis of a specified amount of principal
(the "notional principal amount") for a specified period of time. Interest rate
cap and floor transactions involve an agreement between two parties in which the
first party agrees to make payments to the counterparty when a designated market
interest rate goes above (in the case of a cap) or below (in the case of a
floor) a designated level on predetermined dates or during a specified time
period. Interest rate collar transactions involve an agreement between two
parties in which payments are made when a designated market interest rate either
goes above a designated ceiling level or goes below a designated floor level on
predetermined dates or during a specified time period.
28
<PAGE>
A fund may enter into interest rate swap transactions to preserve a return
or spread on a particular investment or portion of its portfolio or to protect
against any increase in the price of securities it anticipates purchasing at a
later date. A fund may only use these transactions as a hedge and not as a
speculative investment. Interest rate swap transactions are subject to risks
comparable to those described above with respect to other hedging strategies.
A fund may enter into interest rate swaps, caps, floors and collars 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 a fund
receiving or paying, as the case may be, only the net amount of the two
payments. Inasmuch as these interest rate swap transactions are entered into for
good faith hedging purposes, and inasmuch as segregated accounts will be
established with respect to such transactions, Mitchell Hutchins and (for Low
Duration Fund) the sub-adviser believe such obligations do not constitute senior
securities and, accordingly, will not treat them as being subject to a fund's
borrowing restrictions. The net amount of the excess, if any, of a fund's
obligations over its entitlements with respect to each interest rate swap will
be accrued on a daily basis, and appropriate fund assets having an aggregate net
asset value at least equal to the accrued excess will be maintained in a
segregated account as described above in "The Funds' Investments, Related Risks
and Limitations--Segregated Accounts." A fund also will establish and maintain
such segregated accounts with respect to its total obligations under any swaps
that are not entered into on a net basis and with respect to any caps, floors
and collars that are written by the fund.
A fund will enter into swap transactions only with banks and recognized
securities dealers believed by Mitchell Hutchins or the sub-adviser to present
minimal credit risk in accordance with guidelines established by the fund's
board. If there is a default by the other party to such a transaction, a fund
28a
<PAGE>
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.
ORGANIZATION OF TRUSTS; TRUSTEES AND OFFICERS
AND PRINCIPAL HOLDERS OF SECURITIES
Managed Trust was formed on November 21, 1986 as a business trust under
the laws of the Commonwealth of Massachusetts and has seven operating series.
Securities Trust was formed on December 3, 1992 as a business trust under the
laws of the Commonwealth of Massachusetts and has two operating series. Each
Trust is governed by a board of trustees, which is authorized to establish
additional series and to issue an unlimited number of shares of beneficial
interest of each existing or future series, par value $0.001 per share. The
applicable board oversees each fund's operations.
The trustees and executive officers of each Trust, their ages, business
addresses and principal occupations during the past five years are:
<TABLE>
<CAPTION>
NAME AND ADDRESS*; AGE POSITION WITH EACH TRUST BUSINESS EXPERIENCE; OTHER DIRECTORSHIPS
---------------------- ------------------------ ----------------------------------------
<S> <C> <C>
Margo N. Alexander**; 52 Trustee and President Mrs. Alexander is chairman (since March
1999), chief executive officer and a
director of Mitchell Hutchins (since
January 1995), and an executive vice
president and a director of PaineWebber
(since March 1984). Mrs. Alexander is
president and a director or trustee of 32
investment companies for which Mitchell
Hutchins, PaineWebber or one of their
affiliates serves as investment adviser.
Richard Q. Armstrong; 63 Trustee Mr. Armstrong is chairman and principal
R.Q.A. Enterprises of R.Q.A. Enterprises (management
One Old Church Road consulting firm) (since April 1991 and
Unit #6 principal occupation since March 1995).
Greenwich, CT 06830 Mr. Armstrong was chairman of the board,
chief executive officer and co-owner of
Adirondack Beverages (producer and
distributor of soft drinks and
sparkling/still waters) (October
1993-March 1995). He was a partner of The
New England Consulting Group (management
consulting firm) (December 1992-September
1993). He was managing director of LVMH
U.S. Corporation (U.S. subsidiary of the
French luxury goods conglomerate, Louis
Vuitton Moet Hennessey Corporation)
(1987-1991) and chairman of its wine and
spirits subsidiary, Schieffelin & Somerset
Company (1987-1991). Mr. Armstrong is a
director or trustee of 31 investment
companies for which Mitchell Hutchins,
PaineWebber or one of their affiliates
serves as investment adviser.
E. Garrett Bewkes, Jr.**; 72 Trustee and Chairman Mr. Bewkes is a director of Paine Webber
of the Board of Trustees Group Inc. ("PW Group") (holding company
of PaineWebber and Mitchell Hutchins).
Prior to December 1995, he was a
consultant to PW Group. Prior to 1988, he
was chairman of the board, president and
chief executive officer of American
Bakeries Company. Mr. Bewkes is a director
of Interstate Bakeries Corporation. Mr.
Bewkes is a director or trustee of 35
investment companies for which Mitchell
Hutchins, PaineWebber or one of their
affiliates serves as investment adviser.
29
<PAGE>
NAME AND ADDRESS*; AGE POSITION WITH EACH TRUST BUSINESS EXPERIENCE; OTHER DIRECTORSHIPS
---------------------- ------------------------ ----------------------------------------
Richard R. Burt; 52 Trustee Mr. Burt is chairman of IEP Advisors,
1275 Pennsylvania Ave, N.W. Inc. (international investments and
Washington, DC 20004 consulting firm) (since March 1994) and a
partner of McKinsey & Company (management
consulting firm) (since 1991). He is also
a director of Archer-Daniels-Midland Co.
(agricultural commodities), Hollinger
International Co. (publishing), Homestake
Mining Corp., Powerhouse Technologies Inc.
and Wierton Steel Corp. He was the chief
negotiator in the Strategic Arms Reduction
Talks with the former Soviet Union
(1989-1991) and the U.S. Ambassador to the
Federal Republic of Germany (1985-1989).
Mr. Burt is a director or trustee of 31
investment companies for which Mitchell
Hutchins, PaineWebber or one of their
affiliates serves as investment adviser.
Mary C. Farrell**; 49 Trustee Ms. Farrell is a managing director,
senior investment strategist and member of
the Investment Policy Committee of
PaineWebber. Ms. Farrell joined
PaineWebber in 1982. She is a member of
the Financial Women's Association and
Women's Economic Roundtable and appears as
a regular 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 31
investment companies for which Mitchell
Hutchins, PaineWebber or one of their
affiliates serves as investment adviser.
Meyer Feldberg; 57 Trustee Mr. Feldberg is Dean and Professor of
Columbia University Management of the Graduate School of
101 Uris Hall Business, Columbia University. Prior to
New York, NY 10027 1989, he was president of the Illinois
Institute of Technology. Dean Feldberg is
also a director of Primedia, Inc.,
Federated Department Stores, Inc. and
Revlon, Inc. Dean Feldberg is a director
or trustee of 34 investment companies for
which Mitchell Hutchins, PaineWebber or
one of their affiliates serves as
investment adviser.
George W. Gowen; 69 Trustee Mr. Gowen is a partner in the law firm of
666 Third Avenue Dunnington, Bartholow & Miller. Prior to
New York, NY 10017 May 1994, he was a partner in the law
firm of Fryer, Ross & Gowen. Mr. Gowen is
a director or trustee of 34 investment
companies for which Mitchell Hutchins,
PaineWebber or one of their affiliates
serves as investment adviser.
30
<PAGE>
NAME AND ADDRESS*; AGE POSITION WITH EACH TRUST BUSINESS EXPERIENCE; OTHER DIRECTORSHIPS
---------------------- ------------------------ ----------------------------------------
Frederic V. Malek; 62 Trustee Mr. Malek is chairman of Thayer Capital
1455 Pennsylvania Ave, N.W. Partners (merchant bank). From January
Suite 350 1992 to November 1992, he was campaign
Washington, DC 20004 manager of Bush-Quayle `92. From 1990 to
1992, he was vice chairman and, from 1989
to 1990, he was president of Northwest
Airlines Inc., NWA Inc. (holding company
of Northwest Airlines Inc.) and Wings
Holdings Inc. (holding company of NWA
Inc.). Prior to 1989, he was employed by
the Marriott Corporation (hotels,
restaurants, airline catering and contract
feeding), where he most recently was an
executive vice president and president of
Marriott Hotels and Resorts. Mr. Malek is
also a director of American Management
Systems, Inc. (management consulting and
computer related services), Automatic Data
Processing, Inc., CB Commercial Group,
Inc. (real estate services), Choice Hotels
International (hotel and hotel
franchising), FPL Group, Inc. (electric
services), Manor Care, Inc. (health care)
and Northwest Airlines Inc. Mr. Malek is a
director or trustee of 31 investment
companies for which Mitchell Hutchins,
PaineWebber or one of their affiliates
serves as investment adviser.
Carl W. Schafer; 63 Trustee Mr. Schafer is president of the Atlantic
66 Witherspoon Street, #1100 Foundation (charitable foundation
Princeton, NJ 08542 supporting mainly oceanographic
exploration and research). He is a
director of Base Ten Systems, Inc.
(software), Roadway Express, Inc.
(trucking), The Guardian Group of Mutual
Funds, the Harding, Loevner Funds, Evans
Systems, Inc. (motor fuels, convenience
store and diversified company), Electronic
Clearing House, Inc. (financial
transactions processing), Frontier Oil
Corporation and Nutraceutix, Inc.
(biotechnology company). Prior to January
1993, he was chairman of the Investment
Advisory Committee of the Howard Hughes
Medical Institute. Mr. Schafer is a
director or trustee of 31 investment
companies for which Mitchell Hutchins,
PaineWebber or one of their affiliates
serves as investment adviser.
T. Kirkham Barneby; 52 Vice President Mr. Barneby is a managing director and
(Managed Trust only) chief investment officer--quantitative
investments of Mitchell Hutchins. Prior to
September 1994, he was a senior vice
president at Vantage Global Management.
Mr. Barneby is a vice president of seven
investment companies for which Mitchell
Hutchins, PaineWebber or one of their
affiliates serves as investment adviser.
31
<PAGE>
NAME AND ADDRESS*; AGE POSITION WITH EACH TRUST BUSINESS EXPERIENCE; OTHER DIRECTORSHIPS
---------------------- ------------------------ ----------------------------------------
Julieanna Berry; 35 Vice President Ms. Berry is a first vice president and a
(Managed Trust only) portfolio manager of Mitchell Hutchins.
Ms. Berry is a vice president of two
investment companies for which Mitchell
Hutchins, PaineWebber or one of their
affiliates serves as investment adviser.
Karen Finkel; 41 Vice President Mrs. Finkel is a senior vice president
(Managed Trust only) and a portfolio manager of Mitchell
Hutchins. Mrs. Finkel is a vice president
of three investment companies for which
Mitchell Hutchins, PaineWebber or one of
their affiliates serves as investment
adviser.
31a
<PAGE>
NAME AND ADDRESS*; AGE POSITION WITH EACH TRUST BUSINESS EXPERIENCE; OTHER DIRECTORSHIPS
---------------------- ------------------------ ----------------------------------------
Donald R. Jones; 38 Vice President Mr. Jones is a senior vice president and
(Securities Trust a portfolio manager of Mitchell
only) Hutchins. Prior to February 1996, he was
a vice president in the asset management
group of First Fidelity Bancorporation.
Mr. Jones is a vice president of two
investment companies for which Mitchell
Hutchins, PaineWebber or one of their
affiliates serves as investment adviser.
James F. Keegan; 38 Vice President Mr. Keegan is a senior vice president and
(Managed Trust only) a 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
companies for which Mitchell Hutchins,
PaineWebber or one of their affiliates
serves as investment adviser.
John J. Lee; 30 Vice President and Mr. Lee is a vice president and a manager
Assistant Treasurer of the mutual fund finance department of
Mitchell Hutchins. Prior to September
1997, he was an audit manager in the
financial services practice of Ernst &
Young LLP. Mr. Lee is a vice president and
assistant treasurer of 32 investment
companies for which Mitchell Hutchins,
PaineWebber or one of their affiliates
serves as an investment adviser.
Thomas J. Libassi; 40 Vice President Mr. Libassi is a senior vice president
and portfolio manager of Mitchell
Hutchins. Prior to May 1994, he was a vice
president of Keystone Custodian Funds Inc.
with portfolio management responsibility.
Mr. Libassi is a vice president of six
investment companies for which Mitchell
Hutchins, PaineWebber or one of their
affiliates serves as investment adviser.
Dennis McCauley; 52 Vice President Mr. McCauley is a managing director and
chief investment officer--fixed income of
Mitchell Hutchins. Prior to December 1994,
he was director of fixed income
investments of IBM Corporation. Mr.
McCauley is a vice president of 22
investment companies for which Mitchell
Hutchins, PaineWebber or one of their
affiliates serves as investment adviser.
Ann E. Moran; 41 Vice President and Ms. Moran is a vice president and a
Assistant Treasurer manager of the mutual fund finance
department of Mitchell Hutchins. Ms. Moran
is a vice president and assistant
treasurer of 32 investment companies for
which Mitchell Hutchins, PaineWebber or
one of their affiliates serves as
investment adviser.
32
<PAGE>
NAME AND ADDRESS*; AGE POSITION WITH EACH TRUST BUSINESS EXPERIENCE; OTHER DIRECTORSHIPS
---------------------- ------------------------ ----------------------------------------
Dianne E. O'Donnell; 46 Vice President and Ms. O'Donnell is a senior vice president
Secretary and deputy general counsel of Mitchell
Hutchins. Ms. O'Donnell is a vice
president and secretary of 31 investment
companies and a vice president and
assistant secretary of one investment
company for which Mitchell Hutchins,
PaineWebber or one of their affiliates
serves as investment adviser.
Emil Polito; 38 Vice President Mr. Polito is a senior vice president and
director of operations and control for
Mitchell Hutchins. Mr. Polito is a vice
president of 32 investment companies for
which Mitchell Hutchins, PaineWebber or
one of their affiliates serves as
investment adviser.
32a
<PAGE>
NAME AND ADDRESS*; AGE POSITION WITH EACH TRUST BUSINESS EXPERIENCE; OTHER DIRECTORSHIPS
---------------------- ------------------------ ----------------------------------------
Victoria E. Schonfeld; 48 Vice President Ms. Schonfeld is a managing director and
general counsel of Mitchell Hutchins
(since May 1994) and a senior vice
president of PaineWebber (since July
1995). Prior to May 1994, she was a
partner in the law firm of Arnold &
Porter. Ms. Schonfeld is a vice president
of 31 investment companies and a vice
president and secretary of one investment
company for which Mitchell Hutchins,
PaineWebber or one of their affiliates
serves as investment adviser.
Paul H. Schubert; 36 Vice President and Mr. Schubert is a senior vice president
Treasurer and director of the mutual fund finance
department of Mitchell Hutchins. From
August 1992 to August 1994, he was a vice
president at BlackRock Financial
Management L.P. Mr. Schubert is a vice
president and treasurer of 32 investment
companies for which Mitchell Hutchins,
PaineWebber or one of their affiliates
serves as investment adviser.
Nirmal Singh; 42 Vice President Mr. Singh is a senior vice president and
a portfolio manager of Mitchell Hutchins.
Mr. Singh is a vice president of four
investment companies for which Mitchell
Hutchins, PaineWebber or one of their
affiliates serves as investment adviser.
Barney A. Taglialatela; 38 Vice President and Mr. Taglialatela is a vice president and
Assistant Treasurer a manager of the mutual fund finance
department of Mitchell Hutchins. Prior to
February 1995, he was a manager of the
mutual fund finance division of Kidder
Peabody Asset Management, Inc. Mr.
Taglialatela is a vice president and
assistant treasurer of 32 investment
companies for which Mitchell Hutchins,
PaineWebber or one of their affiliates
serves as investment adviser.
Mark A. Tincher; 43 Vice President Mr. Tincher is a managing director and
chief investment officer--equities of
Mitchell Hutchins. Prior to March 1995, he
was a vice president and directed the U.S.
funds management and equity research areas
of Chase Manhattan Private Bank. Mr.
Tincher is a vice president of 13
investment companies for which Mitchell
Hutchins, PaineWebber or one of their
affiliates serves as investment adviser.
33
<PAGE>
NAME AND ADDRESS*; AGE POSITION WITH EACH TRUST BUSINESS EXPERIENCE; OTHER DIRECTORSHIPS
---------------------- ------------------------ ----------------------------------------
Stuart Waugh; 43 Vice President Mr. Waugh is a managing director and a
(Securities Trust portfolio manager of Mitchell Hutchins
only) responsible for global fixed income
investments and currency trading. Mr.
Waugh is a vice president of five
investment companies for which Mitchell
Hutchins, PaineWebber or one of their
affiliates serves as investment adviser.
Keith A. Weller; 37 Vice President and Mr. Weller is a first vice president and
Assistant Secretary 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 31 investment companies for
which Mitchell Hutchins, PaineWebber or
one of their affiliates serves as
investment adviser.
- -------------
* 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 each fund as defined in
the Investment Company Act of 1940 by virtue of their positions with Mitchell Hutchins,
PaineWebber, and/or PW Group.
</TABLE>
33a
<PAGE>
Board members are compensated as follows:
o MANAGED TRUST has seven operating series and pays each trustee who
is not an "interested person" of the Trust $1,000 annually for each
series. Therefore, Managed Trust pays each such trustee $7,000
annually, plus any additional amounts due for board or committee
meetings.
o SECURITIES TRUST has two operating series and pays each board member
who is not an "interested person" of the Trust $1,000 annually for
Strategic Income Fund and an additional $1,500 annually for its
second series. Therefore, Securities Trust pays each such board
member $2,500 annually, plus any additional amounts due for board or
committee meetings.
Each Trust pays up to $150 per series for each board meeting and each
separate meeting of a board committee. Each chairman of the audit and contract
review committees of individual funds within the PaineWebber fund complex
receives additional compensation, aggregating $15,000 annually, from the
relevant funds. All board members are reimbursed for any expenses incurred in
attending meetings. Board members and officers own in the aggregate less than 1%
of the outstanding shares of any class of each fund. Because PaineWebber,
Mitchell Hutchins and (for Low Duration Fund) the sub-adviser perform
substantially all the services necessary for the operation of the Trusts and
each fund, the Trusts require no employees. No officer, director or employee of
Mitchell Hutchins or PaineWebber presently receives any compensation from the
Trust for acting as a board member or officer.
34
<PAGE>
The table below includes certain information relating to the compensation
of the current board members who held office with the Trusts or with other
PaineWebber funds during the funds' fiscal years ended November 30, 1998.
COMPENSATION TABLE+
AGGREGATE TOTAL
AGGREGATE COMPENSATION COMPENSATION
COMPENSATION FROM FROM THE TRUSTS
FROM MANAGED SECURITIES AND THE FUND
NAME OF PERSON, POSITION TRUST* TRUST* COMPLEX**
------------------------ ------------ ------------ ---------------
Richard Q. Armstrong, $11,580 $ 4,330 $101,372
Trustee
Richard R. Burt, 11,580 4,180 101,372
Trustee
Meyer Feldberg, 11,580 5,798 116,222
Trustee
George W. Gowen, 13,470 4,030 108,272
Trustee
Frederic V. Malek, 11,580 4,330 101,372
Trustee
Carl W. Schafer, 11,580 4,330 101,372
Trustee
- --------------------
+ Only independent board members are compensated by the Trusts and identified
above; board members who are "interested persons," as defined by the
Investment Company Act of 1940, do not receive compensation.
* Represents fees paid to each Trustee from the Trust indicated for the fiscal
year ended November 30, 1998.
** Represents total compensation paid during the calendar year ended December
31, 1998, to each board member by 31 investment companies (33 in the case of
Messrs. Feldberg and Gowen) for which Mitchell Hutchins, PaineWebber or one
of their affiliates served as investment adviser. No fund within the
PaineWebber fund complex has a bonus, pension, profit sharing or retirement
plan.
PRINCIPAL HOLDERS OF SECURITIES
As of March 1, 1999, the funds' records showed no shareholders as owning
5% or more of any class of a fund's shares.
INVESTMENT ADVISORY AND DISTRIBUTION ARRANGEMENTS
INVESTMENT ADVISORY ARRANGEMENTS. Mitchell Hutchins acts as the investment
adviser and administrator to each fund pursuant to a separate contract (each an
"Advisory Contract") with each Trust. The Advisory Contract for Managed Trust is
dated April 21, 1988 and supplemented by a separate fee agreement dated March
26, 1993 with respect to Low Duration Fund. The Advisory Contract for Securities
Trust is dated January 29, 1993 and supplemented by a separate fee agreement
dated January 28, 1994 with respect to Strategic Income Fund. Under the
applicable Advisory Contract, Strategic Income Fund pays Mitchell Hutchins a
fee, computed daily and paid monthly, at the annual rate of 0.75% of its average
daily net assets, and each of the other four 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.
35
<PAGE>
During each of the periods indicated, Mitchell Hutchins earned (or
accrued) advisory fees in the amounts set forth below:
FISCAL YEARS ENDED NOVEMBER 30,
1998 1997 1996
---- ---- ----
U.S. Government Income Fund $1,751,719 $1,979,329 $2,517,534
Low Duration Fund 708,240 819,616 1,272,455
Investment Grade Income Fund 1,456,093 1,464,164 1,685,067
High Income Fund 3,036,812 2,918,855 2,656,610
FISCAL YEAR FISCAL YEAR TEN MONTHS FISCAL YEAR
ENDED ENDED ENDED ENDED
NOVEMBER 30, NOVEMBER 30, NOVEMBER 30, JANUARY 31,
1998 1997 1996 1996
------------ ------------ ------------ -----------
Strategic Income Fund $ 779,494 $ 520,540* $ 407,534 $ 546,119
- ----------------
* Prior to fee waiver of $13,206. Net fees paid by Strategic Income Fund were
$507,334.
The Advisory Contracts authorizes 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 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. For
the fiscal years ended November 30, 1998, November 30, 1997 and November 30,
1996, Mitchell Hutchins paid or accrued sub-advisory fees to PIMCO of $354,120,
$409,808 and $636,228, respectively. PIMCO, a Delaware general partnership, is a
registered investment adviser and a subsidiary partnership of PIMCO Advisors
L.P. ("PIMCO Advisors"). The general partners of PIMCO Advisors are PIMCO
Advisors Holding L.P., a publicly traded company listed on the New York Stock
Exchange under the symbol "PA," and PIMCO Partners, G.P., a general partnership
between Pacific Life Insurance Company and PIMCO Partners, LLC, a limited
liability company controlled by the PIMCO managing directors. PIMCO is one of
the largest fixed income management firms in the nation. Included among PIMCO's
institutional clients are many "Fortune 500" companies.
Prior to August 1, 1997, PaineWebber provided certain services to each
fund not otherwise provided by its transfer agent. Pursuant to a separate
agreement between PaineWebber and each Trust relating to those services,
PaineWebber earned (or accrued) the amounts set forth below during each of the
periods indicated:
EIGHT MONTHS FISCAL YEAR
ENDED JULY 31, ENDED NOVEMBER
1997 30, 1996
---- --------
U.S. Government Income Fund $73,833 $133,159
Low Duration Fund 36,963 70,807
Investment Grade Income Fund 48,036 83,120
High Income Fund 81,517 131,762
EIGHT MONTHS TEN MONTHS FISCAL YEAR
ENDED ENDED ENDED
JULY 31, 1997 NOVEMBER 30, 1996 JANUARY 31, 1996
------------- ----------------- ----------------
Strategic Income Fund $10,503 $14,226 $19,823
Subsequent to July 31, 1997, PFPC (not the funds) pays PaineWebber for
certain transfer agency related services that PFPC has delegated to PaineWebber.
36
<PAGE>
Under the terms of the Advisory Contracts, each fund bears all expenses
incurred in its operation that are not specifically assumed by Mitchell
Hutchins. Expenses borne by each fund include 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 board members and officers who are not interested persons (as defined
in the Investment Company Act of 1940) of the applicable Trust or Mitchell
Hutchins; (6) all expenses incurred in connection with the board members'
services, including travel expenses; (7) taxes (including any income or
franchise taxes) and governmental fees; (8) costs of any liability,
uncollectible items of deposit and other insurance or fidelity bonds; (9) any
costs, expenses or losses arising out of a liability of or claim for damages or
other relief asserted against the applicable Trust or fund for violation of any
law; (10) legal, accounting and auditing expenses, including legal fees of
special counsel for the independent board members; (11) charges of custodians,
transfer agents and other agents; (12) costs of preparing share certificates;
(13) expenses of setting in type and printing prospectuses, statements of
additional information and supplements thereto, reports and proxy materials for
existing shareholders, and costs of mailing such materials to shareholders; (14)
any extraordinary expenses (including fees and disbursements of counsel)
incurred by the 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 board members 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 a
fund in connection with the performance of the Advisory Contract, except a loss
resulting from willful misfeasance, bad faith or gross negligence on the part of
Mitchell Hutchins in the performance of its duties or from reckless disregard of
its duties and obligations thereunder. Each Advisory Contract terminates
automatically 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.
Under the Sub-Advisory Contract, PIMCO will not be liable for any error of
judgment or mistake of law or for any loss suffered by Managed Investments
Trust, Low Duration 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 or
gross negligence on its part in the performance of its duties or from reckless
disregard by it of its obligations and duties under the Sub-Advisory Contract.
The Sub-Advisory Contract terminates automatically upon its assignment or the
termination of the Advisory Contract and is terminable at any time without
penalty by Managed Trust's board or by vote of the holders of a majority of Low
Duration 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 also may 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) upon 120 days' notice to PIMCO.
During the fiscal years ended November 30, 1998 and November 30, 1997, the
indicated fund paid (or accrued) the following fees to PaineWebber for its
services as securities lending agent:
FUND FISCAL YEAR ENDED NOVEMBER 30,
------------------------------
1998 1997
---- ----
U.S. Government Income Fund $ 2,938 672
Low Duration Fund 0 0
Investment Grade Income Fund 24,433 0
High Income Fund 0 0
Strategic Income Fund 8,573 4,254
37
<PAGE>
NET ASSETS. The following table shows the approximate net assets as of
February 28, 1999, 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.
NET ASSETS
INVESTMENT CATEGORY ($MIL)
------------------- ----------
Domestic (excluding Money Market).................... $8,141.2
Global............................................... 4,066.6
Equity/Balanced...................................... 7,127.3
Fixed Income (excluding Money Market)................ 5,080.5
Taxable Fixed Income........................... 3,498.9
Tax-Free Fixed Income........................... 1,581.6
Money Market Funds.................................... 35,357.0
PERSONAL TRADING POLICIES. 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 PaineWebber mutual funds and other
Mitchell Hutchins advisory accounts by all Mitchell Hutchins' directors,
officers and employees, establishes procedures for personal investing and
restricts certain transactions. For example, employee accounts generally must be
maintained at PaineWebber, personal trades in most securities require
pre-clearance and short-term trading and participation in initial public
offerings generally are prohibited. In addition, the code of ethics puts
restrictions on the timing of personal investing in relation to trades by
PaineWebber Funds and other Mitchell Hutchins advisory clients. Personnel of the
sub-adviser may also invest in securities for their own accounts pursuant to
comparable codes of ethics.
DISTRIBUTION ARRANGEMENTS. Mitchell Hutchins acts as the distributor of
each class of shares of each fund under separate distribution contracts with
each Trust (collectively, "Distribution Contracts"). Each Distribution Contract
requires Mitchell Hutchins to use its best efforts, consistent with its other
businesses, to sell shares of the applicable fund. Shares of each fund are
offered continuously. Under separate exclusive dealer agreements between
Mitchell Hutchins and PaineWebber relating to each class of shares of the funds
(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 each Trust in the manner prescribed
under Rule 12b-1 under the Investment Company Act of 1940 (each, respectively, a
"Class A Plan," "Class B Plan" and "Class C Plan," and 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 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. There is no distribution plan with respect to the funds' Class Y
shares.
Mitchell Hutchins uses the service fees under the Plans for Class A, B and
C shares primarily to pay PaineWebber for shareholder servicing, currently at
the annual rate of 0.25% of the aggregate investment amounts maintained in each
fund by PaineWebber clients. PaineWebber then compensates its Financial Advisors
for shareholder servicing that they perform and offsets its own expenses in
servicing and maintaining shareholder accounts.
Mitchell Hutchins uses the distribution fees under the Class B and Class C
Plans to:
o Offset the commissions it pays to PaineWebber for selling each
fund's Class B and Class C shares, respectively.
o Offset each fund's marketing costs attributable to such classes,
such as preparation, printing and distribution of sales literature,
advertising and prospectuses to prospective investors and related
overhead expenses, such as employee salaries and bonuses.
PaineWebber compensates Financial Advisors when Class B and Class C shares
are bought by investors, as well as on an ongoing basis. Mitchell Hutchins
receives no special compensation from any of the funds or investors at the time
Class B or C shares are bought.
38
<PAGE>
Mitchell Hutchins receives the proceeds of the initial sales charge paid
when Class A shares are bought and of the contingent deferred sales charge paid
upon sales of shares. These proceeds may be used to cover distribution expenses.
The Plans and the related Distribution Contracts for Class A, Class B and
Class C shares specify that each fund must pay service and distribution fees to
Mitchell Hutchins for its activities, not as reimbursement for specific expenses
incurred. Therefore, even if Mitchell Hutchins' expenses exceed the service or
distribution fees it receives, the funds will not be obligated to pay more than
those fees. On the other hand, if Mitchell Hutchins' expenses are less than such
fees, it will retain its full fees and realize a profit. Expenses in excess of
service and distribution fees received or accrued through the termination date
of any Plan will be Mitchell Hutchins' sole responsibility and not that of the
funds. Annually, the board of each fund reviews the Plans and Mitchell Hutchins'
corresponding expenses for each class separately from the Plans and expenses of
the other classes.
Among other things, each Plan provides that (1) Mitchell Hutchins will
submit to the applicable board at least quarterly, and the board members 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 applicable board, including those board members 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 board
members who are not "interested persons" of the Trust shall be committed to the
discretion of the board members who are not "interested persons" of that Trust.
In reporting amounts expended under the Plans to the board members,
Mitchell Hutchins allocates expenses attributable to the sale of each class of
each fund's shares to such class based on the ratio of sales of shares of such
class to the sales of all three classes of shares. The fees paid by one class of
a fund's shares will not be used to subsidize the sale of any other class of
fund shares.
The funds paid (or accrued) the following service and/or distribution fees
to Mitchell Hutchins under the Class A, Class B and Class C Plans during the
fiscal year ended November 30, 1998:
<TABLE>
<CAPTION>
U.S. GOVERNMENT LOW DURATION INVESTMENT GRADE HIGH INCOME STRATEGIC
INCOME FUND FUND INCOME FUND FUND INCOME FUND
--------------- ------------ ---------------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Class A.......... $ 712,065 $ 120,959 $ 543,534 $ 685,222 $ 79,357
Class B.......... 295,396 74,245 413,463 2,177,074 446,509
Class C.......... 195,063 631,062 234,797 857,290 204,078
</TABLE>
39
<PAGE>
Mitchell Hutchins estimates that it and its parent corporation,
PaineWebber, incurred the following shareholder service-related and
distribution-related expenses with respect to each fund during the fiscal year
ended November 30, 1998:
<TABLE>
<CAPTION>
U.S INVESTMENT STRATEGIC
GOVERNMENT LOW DURATION GRADE HIGH INCOME INCOME
INCOME FUND FUND INCOME FUND FUND FUND
----------- ------------ ----------- ----------- --------
<S> <C> <C> <C> <C> <C>
CLASS A
Marketing and advertising....... $ 204,878 $ 86,078 $ 188,752 $ 424,495 $ 82,645
Amortization of commissions..... 0 0 0 0 0
Printing of prospectuses and
statements of additional
information..................... 3,254 607 2,406 3,386 356
Branch network costs allocated
and interest expense............ 1,251,838 226,434 811,991 933,726 76,026
Service fees paid to PaineWebber
Financial Advisors.............. 270,586 45,964 206,543 260,385 30,155
CLASS B
Marketing and advertising....... 21,499 13,241 35,820 330,747 112,994
Amortization of commissions..... 90,694 23,445 129,480 657,188 140,180
Printing of prospectuses and
statements of additional
information................ 353 73 457 2,638 493
Branch network costs allocated
and interest expense............ 140,734 36,649 169,352 839,757 129,461
Service fees paid to PaineWebber
Financial Advisors.............. 28,065 7,053 39,280 206,822 42,460
Class C
Marketing and advertising....... 18,702 149,998 27,182 176,327 69,466
Amortization of commissions..... 49,417 159,869 59,482 217,179 51,699
Printing of prospectuses and
statements of additional
information..................... 313 753 383 1,407 298
Branch network costs allocated
and interest expense............ 115,499 397,219 117,886 393,058 66,805
Service fees paid to PaineWebber
Financial Advisors.............. 24,707 79,935 29,740 108,590 25,851
</TABLE>
"Marketing and advertising" includes various internal costs allocated by
Mitchell Hutchins to its efforts at distributing the funds' shares. These
internal costs encompass office rent, salaries and other overhead expenses of
various departments and areas of operations of Mitchell Hutchins. "Branch
network costs allocated and interest expense" consist of an allocated portion of
the expenses of various PaineWebber departments involved in the distribution of
the funds' shares, including the PaineWebber retail branch system.
In approving each fund's overall Flexible PricingSM system of
distribution, the applicable 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 fund and attracting
new investors and assets to the fund to the benefit of the fund and its
shareholders, (2) facilitate distribution of the fund's shares and (3) maintain
the competitive position of the fund in relation to other funds that have
implemented or are seeking to implement similar distribution arrangements.
In approving the Class A Plan, 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 Financial Advisors 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
40
<PAGE>
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, the board of each fund considered all the
features of the distribution system, including (1) the conditions under which
contingent deferred sales charges would be imposed and the amount of such
charges, (2) the advantage to investors in having no initial sales charges
deducted from fund purchase payments and instead having the entire amount of
their purchase payments immediately invested in fund shares, (3) Mitchell
Hutchins' belief that the ability of PaineWebber Financial Advisors 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
Financial Advisors 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 board
members also recognized that Mitchell Hutchins' willingness to compensate
PaineWebber and its Financial Advisors, 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 fund 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 Financial Advisors 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 Financial Advisors 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 board members also recognized
that Mitchell Hutchins' willingness to compensate PaineWebber and its Financial
Advisors, without the concomitant receipt by Mitchell Hutchins of initial sales
charges or contingent deferred sales charges upon redemption after one year
following purchase was conditioned upon its expectation of being compensated
under the Class C Plan.
With respect to each Plan, the boards 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 boards 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 a fund, which
fees would increase if the Plan were successful and the fund attained and
maintained significant asset levels.
41
<PAGE>
Under the Distribution Contract between each Trust and Mitchell Hutchins
for the Class A shares for the fiscal years (or periods) set forth below,
Mitchell Hutchins earned the following approximate amounts of sales charges and
retained the following approximate amounts, net of concessions to PaineWebber as
exclusive dealer.
FISCAL YEAR ENDED NOVEMBER 30,
1998 1997 1996
---- ---- ----
U.S. GOVERNMENT INCOME FUND
Earned............ $ 32,953 $ 13,156 $ 28,937
Retained.......... 5,284 1,562 2,595
LOW DURATION FUND
Earned............ 84,972 14,824 3,734
Retained.......... 1,664 261 211
INVESTMENT GRADE INCOME FUND
Earned............ 151,513 51,469 36,783
Retained.......... 7,946 4,100 2,873
HIGH INCOME FUND
Earned............ 419,260 506,732 220,619
Retained.......... 33,441 36,405 16,318
<TABLE>
<CAPTION>
FISCAL YEAR ENDED NOVEMBER 30,
TEN MONTHS ENDED FISCAL YEAR ENDED
1998 1997 NOVEMBER 30, 1996 JANUARY 31, 1996
---- ---- ----------------- ----------------
<S> <C> <C> <C> <C>
STRATEGIC INCOME FUND
Earned............ $ 163,983 $ 157,647 $ 16,799 $ 7,392
Retained.......... 12,827 11,028 1,119 415
Mitchell Hutchins earned and retained the following contingent deferred sales charges paid upon certain
redemptions of shares for the fiscal year ended November 30, 1998:
U.S. Government Low Duration Investment Grade High Income Strategic
Income Fund Fund Income Fund Fund Income Fund
--------------- ------------ ---------------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Class A............ $ 0 $ 0 $ 0 $ 0 $ 0
Class B............ 48,857 9,319 84,315 678,130 86,638
Class C............ 4,460 10,282 13,980 40,240 6,846
</TABLE>
PORTFOLIO TRANSACTIONS
Subject to policies established by each board, Mitchell Hutchins or (for
Low Duration Fund) the sub-adviser is responsible for the execution of each
fund's portfolio transactions and the allocation of brokerage transactions. In
executing portfolio transactions, Mitchell Hutchins or the sub-adviser seeks to
obtain the best net results for a fund, taking into account such factors as the
price (including the applicable brokerage commission or dealer spread), size of
order, difficulty of execution and operational facilities of the firm involved.
Generally, bonds are traded on the over-the-counter market on a "net" basis
without a stated commission through dealers acting for their own accounts and
not through brokers. Prices paid to dealers in principal transactions generally
include a "spread," which is the difference between the prices at which the
dealer is willing to purchase and sell a specific security at the time. While
Mitchell Hutchins and the sub-adviser generally seek reasonably competitive
commission rates, payment of the lowest commission is not necessarily consistent
with obtaining the best net results.
During the fiscal years or periods indicated, the funds paid the brokerage
commissions set forth below:
42
<PAGE>
Fiscal Years Ended November 30,
1998 1997 1996
---- ---- ----
U.S. GOVERNMENT INCOME FUND..... $ 121,482 $ 105,150 $ 0
LOW DURATION FUND............... 0 0 0
INVESTMENT GRADE INCOME FUND.... 5,412 2,400 2,400
HIGH INCOME FUND................ 8,104 2,939 32,596
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
Fiscal Year Ended Fiscal Year Ended Ten Months Ended Fiscal Year Ended
November 30, 1998 November 30, 1997 November 30, 1996 January 31, 1996
----------------- ----------------- ----------------- ----------------
STRATEGIC INCOME FUND $ 10,079 $ 0 $ 0 $ 0
</TABLE>
The funds have no 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, or (for Low Duration Fund) brokerage affiliates of the
sub-adviser. Each board has adopted procedures in conformity with Rule 17e-1
under the Investment Company Act of 1940 to ensure that all brokerage
commissions paid to PaineWebber or brokerage affiliates of the sub-adviser are
reasonable and fair. Specific provisions in the Advisory Contracts and the
Sub-Advisory Contract authorize Mitchell Hutchins and the sub-adviser,
respectively, and any of their affiliates that is a member of a national
securities exchange to effect portfolio transactions for the applicable fund on
such exchange and to retain compensation in connection with such transactions.
Any such transactions will be effected and related compensation paid only in
accordance with applicable SEC regulations. None of the funds paid brokerage
commissions to PaineWebber or (for Low Duration Fund) brokerage affiliates of
the sub-adviser during the fiscal years or periods ended November 30, 1998,
November 30, 1997, November 30, 1996 or (for Strategic Income Fund) the fiscal
year ended January 31, 1996.
Transactions in futures contracts are executed through futures commission
merchants ("FCMs"), who receive brokerage commissions for their services. The
funds' procedures in selecting FCMs to execute their transactions in futures
contracts, including procedures permitting the use of Mitchell Hutchins and its
affiliates or affiliates of the sub-adviser, are similar to those in effect with
respect to brokerage transactions in securities.
Consistent with the interests of the funds and subject to the review of
each board, Mitchell Hutchins or (for Low Duration Fund) the sub-adviser may
cause a fund to purchase and sell portfolio securities through brokers who
provide Mitchell Hutchins or the sub-adviser with research, analysis, advice and
similar services. The funds may pay to those brokers a higher commission than
may be charged by other brokers, provided that Mitchell Hutchins or the
sub-adviser 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 the sub-adviser, as applicable, 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. For the fiscal year
ended November 30, 1998, the funds directed the portfolio transactions indicated
below to brokers chosen because they provide research, analysis, advice and
similar services, for which the funds paid the brokerage commissions indicated
below:
FUND AMOUNT OF PORTFOLIO BROKERAGE
---- TRANSACTIONS COMMISSIONS PAID
------------------- ----------------
U.S. Government Income Fund...... $ 0 $ 0
Low Duration Fund................ 0 0
Investment Grade Income Fund..... 0 0
High Income Fund................. 184,641 386
Strategic Income Fund............ 0 0
For purchases or sales with broker-dealer firms that act as principal,
Mitchell Hutchins or (for Low Duration Fund) the sub-adviser, as applicable,
seeks best execution. Although Mitchell Hutchins or the sub-adviser may receive
certain research or execution services in connection with these transactions,
Mitchell Hutchins and the sub-adviser will not purchase securities at a higher
price or sell securities at a lower price than would otherwise be paid if no
weight was attributed to the services provided by the executing dealer.
Moreover, Mitchell Hutchins and the sub-adviser will not enter into any explicit
soft dollar arrangements relating to principal transactions and will not receive
43
<PAGE>
in principal transactions the types of services that could be purchased for hard
dollars. Mitchell Hutchins or the sub-adviser may engage in agency transactions
in over-the-counter 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
the sub-adviser receiving multiple quotes from dealers before executing the
transactions on an agency basis.
Information and research services furnished by brokers or dealers through
which or with which the funds effect securities transactions may be used by
Mitchell Hutchins or (for Low Duration Fund) the sub-adviser in advising other
funds or accounts and, conversely, research services furnished to Mitchell
Hutchins or the sub-adviser by brokers or dealers in connection with other funds
or accounts that either of them advises may be used in advising the funds.
Information and research received from 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 Contracts or the sub-adviser under the Sub-Advisory
Contract.
Investment decisions for a fund and for other investment accounts managed
by Mitchell Hutchins or (for Low Duration Fund) by the sub-adviser are made
independently of each other in light of differing considerations for the various
accounts. However, the same investment decision may occasionally be made for a
fund and one or more of such accounts. In such cases, simultaneous transactions
are inevitable. Purchases or sales are then averaged as to price and allocated
between that fund and such other account(s) as to amount according to a formula
deemed equitable to the fund and such account(s). While in some cases this
practice could have a detrimental effect upon the price or value of the security
as far as the funds are concerned, or upon their ability to complete their
entire order, in other cases it is believed that coordination and the ability to
participate in volume transactions will be beneficial to the funds.
The funds will not purchase securities that are offered in underwritings
in which PaineWebber or (for Low Duration Fund) an affiliate of the sub-adviser
is a member of the underwriting or selling group, except pursuant to procedures
adopted by each board pursuant to Rule 10f-3 under the Investment Company Act of
1940. Among other things, these procedures require that the spread or commission
paid in connection with such a purchase be reasonable and fair, the purchase be
at not more than the public offering price prior to the end of the first
business day after the date of the public offering and that PaineWebber or any
affiliate thereof or an affiliate of the sub-adviser not participate in or
benefit from the sale to the fund.
As of November 30, 1998, the funds owned securities issued by their
regular broker-dealers as follows:
Low Duration Fund had entered into a repurchase agreement transaction with
State Street Bank and Trust Company ($2,977,000).
Investment Grade Income Fund had entered into a repurchase agreement
transaction with Bear Stearns Co. Inc. ($12,000,000) and Morgan Stanley
Dean Witter & Co. ($11,497,000).
High Income Fund had entered into a repurchase agreement with Societe
Generale ($14,632,000).
PORTFOLIO TURNOVER. The funds' annual portfolio turnover rates may vary
greatly from year to year, but they will not be a limiting factor when
management deems portfolio changes appropriate. The portfolio turnover rate is
calculated by dividing the lesser of a fund's annual sales or purchases of
portfolio securities (exclusive of purchases or sales of securities whose
maturities at the time of acquisition were one year or less) by the monthly
average value of securities in the portfolio during the year.
The funds' respective portfolio turnover rates for the fiscal years shown
were:
FISCAL YEARS ENDED NOVEMBER 30,
1998 1997
---- ----
U.S. GOVERNMENT INCOME FUND 370% 322%
LOW DURATION FUND 411% 359%
INVESTMENT GRADE INCOME FUND 173% 109%
HIGH INCOME FUND 161% 160%
STRATEGIC INCOME FUND 192% 140%
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REDUCED SALES CHARGES, ADDITIONAL EXCHANGE AND REDEMPTION
INFORMATION AND OTHER SERVICES
WAIVERS OF SALES CHARGES/CONTINGENT DEFERRED SALES CHARGES -- CLASS A
SHARES. The following additional sales charge waivers are available for Class A
shares if you:
o Purchase shares through a variable annuity offered only to qualified
plans. For investments made pursuant to this waiver, Mitchell Hutchins
may make payments out of its own resources to PaineWebber and to the
variable annuity's sponsor, adviser or distributor in a total amount
not to exceed l% of the amount invested;
o Acquire shares through an investment program that is not sponsored by
PaineWebber or its affiliates and that charges participants a fee for
program services, provided that the program sponsor has entered into a
written agreement with PaineWebber permitting the sale of shares at net
asset value to that program. For investments made pursuant to this
waiver, Mitchell Hutchins may make a payment to PaineWebber out of its
own resources in an amount not to exceed 1% of the amount invested. For
subsequent investments or exchanges made to implement a rebalancing
feature of such an investment program, the minimum subsequent
investment requirement is also waived;
o Acquire shares in connection with a reorganization pursuant to which a
fund acquires substantially all of the assets and liabilities of
another fund in exchange solely for shares of the acquiring fund; or
o Acquire shares in connection with the disposition of proceeds from the
sale of shares of Managed High Yield Plus Fund Inc. that were acquired
during that fund's initial public offering of shares and that meet
certain other conditions described in its prospectus
In addition, reduced sales charges on Class A shares are available through
the combined purchase plan or through rights of accumulation described below.
Class A share purchases of $1 million or more are not subject to an initial
sales charge; however, if a shareholder sells these shares within one year after
purchase, a contingent deferred sales charge of 1% of the offering price or the
net asset value of the shares at the time of sale by the shareholder, whichever
is less, is imposed.
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 indicated in
the tables of sales charges for Class A shares 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;
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(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); or
(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.
REINSTATEMENT PRIVILEGE -- CLASS A SHARES. Shareholders who have redeemed
Class A shares of a fund may reinstate their account without a sales charge 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, although a loss arising out of a
redemption might not be deductible under certain circumstances. See "Taxes"
below.
WAIVERS OF CONTINGENT DEFERRED SALES CHARGES -- CLASS B SHARES. The
maximum 5% contingent deferred sales charge (3% for Low Duration Fund) applies
to sales of shares during the first year after purchase. The charge generally
declines by 1% annually, reaching zero after six years (four years for Low
Duration Fund). Among other circumstances, the contingent deferred sales charge
on Class B shares is waived where a total or partial redemption is made within
one year following the death of the shareholder. The contingent deferred sales
charge waiver is available where the decedent is either the sole shareholder or
owns the shares with his or her spouse as a joint tenant with right of
survivorship. This waiver applies only to redemption of shares held at the time
of death.
PURCHASES OF CLASS Y SHARES THROUGH THE PACE MULTI ADVISOR PROGRAM. An
investor who participates in the PACE Multi Advisor Program is eligible to
purchase Class Y shares. The PACE Multi Advisor Program is an advisory program
sponsored by PaineWebber that provides comprehensive investment services,
including investor profiling, a personalized asset allocation strategy using an
appropriate combination of funds, and a quarterly investment performance review.
Participation in the PACE Multi Advisor Program is subject to payment of an
advisory fee at the effective maximum annual rate of 1.5% of assets. Employees
of PaineWebber and its affiliates are entitled to a waiver of this fee. Please
contact your PaineWebber Financial Advisor or PaineWebber's correspondent firms
for more information concerning mutual funds that are available through the PACE
Multi Advisor Program.
PURCHASES AND SALES OF CLASS Y SHARES FOR PARTICIPANTS IN PW 401(K) PLUS
PLAN. The trustee of the PW 401(k) Plus Plan, a defined contribution plan
sponsored by PW Group, buys and sells Class Y shares of the funds to implement
the investment choices of individual plan participants with respect to their PW
401(k) Plus Plan contributions. Individual plan participants should consult the
Summary Plan Description and other plan material of the PW 401(k) Plus Plan
(collectively, "Plan Documents") for a description of the procedures and
limitations applicable to making and changing investment choices. Copies of the
Plan Documents are available from the Benefits Connection, 100 Halfday Road,
Lincolnshire, IL 60069 or by calling 1-888-PWEBBER (1-888-793-2237). As
described in the Plan Documents, the price at which Class Y shares are bought
and sold by the trustee of PW 401(k) Plus Plan might be more or less than the
price per share at the time the participants made their investment choices.
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. Class Y shares are
not eligible for exchange. Shareholders will receive at least 60 days' notice of
any termination or material modification of the exchange offer, except 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.
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If conditions exist that 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 fund has
elected, however, to be governed by Rule 18f-1 under the Investment Company Act
of 1940, under which it is obligated to redeem shares solely in cash up to the
lesser of $250,000 or 1% of its net asset value during any 90-day period for one
shareholder. This election is irrevocable unless the SEC permits its withdrawal.
The funds may suspend redemption privileges or postpone the date of
payment during any period (1) when the New York Stock Exchange is closed or
trading on the New York Stock Exchange 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.
SERVICE ORGANIZATIONS. A fund may authorize service organizations, and
their agents, to accept on its behalf purchase and redemption orders that are in
"good form." A fund will be deemed to have received these purchase and
redemption orders when a service organization or its agent accepts them. Like
all customer orders, these orders will be priced based on the fund's net asset
value next computed after receipt of the order by the service organizations or
their agents. Service organizations may include retirement plan service
providers who aggregate purchase and redemption instructions received from
numerous retirement plans or plan participants.
AUTOMATIC INVESTMENT PLAN. PaineWebber offers an automatic investment plan
with a minimum initial investment of $1,000 through which a fund will deduct $50
or more on a monthly, quarterly, semi-annual or annual basis from the investor's
bank account to invest directly in the fund. Participation in the automatic
investment plan enables an investor to use the technique of "dollar cost
averaging." When an 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, 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 both low and high
price levels.
SYSTEMATIC WITHDRAWAL PLAN. The systematic withdrawal plan allows
investors to set up monthly, quarterly (March, June, September and December),
semi-annual (June and December) or annual (December) withdrawals from their
PaineWebber Mutual Fund accounts. Minimum balances and withdrawals vary
according to the class of shares:
o Class A and Class C shares. Minimum value of fund shares is $5,000;
minimum withdrawals of $100.
o Class B shares. Minimum value of fund shares is $20,000; minimum monthly,
quarterly, and semi-annual and annual withdrawals of $200, $400, $600 and
$800, respectively.
Withdrawals under the systematic withdrawal plan will not be subject to a
contingent deferred sales charge if the investor withdraws no more than 12% of
the value of the fund account when the investor signed up for the Plan (for
Class B shares, annually; for Class A and Class C shares, during the first year
under the Plan). Shareholders who elect to receive dividends or other
distributions in cash may not participate in this 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 the minimum values specified
above. Purchases of additional shares of a fund concurrent with withdrawals are
ordinarily disadvantageous to shareholders because of tax liabilities and, for
Class A shares, initial sales charges. On or about the 20th of a month for
monthly, quarterly, semi-annual and annual plans, PaineWebber will arrange for
redemption by the funds of sufficient fund shares to provide the withdrawal
payments specified by participants in the funds' systematic withdrawal plan. The
payments generally are mailed approximately five Business Days (defined under
"Valuation of Shares") after the redemption date. Withdrawal payments should not
be considered dividends, but redemption proceeds. If periodic withdrawals
continually exceed reinvested dividends and other distributions, a shareholder's
investment may be correspondingly reduced. A shareholder may change the amount
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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. 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 PFPC. Shareholders may request the
forms needed to establish a systematic withdrawal plan from their PaineWebber
Financial Advisors, correspondent firms or PFPC at 1-800-647-1568.
INDIVIDUAL RETIREMENT ACCOUNTS. Self-directed IRAs are available through
PaineWebber in which purchases of PaineWebber mutual funds and other investments
may be made. Investors considering establishing an IRA should review applicable
tax laws and should consult their tax advisers.
TRANSFER OF ACCOUNTS. If investors holding shares of a fund in a
PaineWebber brokerage account transfer their brokerage accounts to another firm,
the fund shares will be moved to an account with PFPC. However, if the other
firm has entered into a selected dealer agreement with Mitchell Hutchins
relating to the fund, the shareholder may be able to hold fund shares in an
account with the other firm.
PAINEWEBBER RMA RESOURCE ACCUMULATION PLAN (SERVICEMARK);
PAINEWEBBER RESOURCE MANAGEMENT ACCOUNT(REGISTERED MARK)) (RMA)(REGISTERED MARK)
Shares of PaineWebber mutual funds (each a "PW Fund" and, collectively,
the "PW Funds") are available for purchase through the RMA Resource Accumulation
Plan ("Plan") by customers of PaineWebber and its correspondent firms who
maintain Resource Management Accounts ("RMA accountholders"). The Plan allows an
RMA accountholder to continually invest in one or more of the PW Funds at
regular intervals, with payment for shares purchased automatically deducted from
the client's RMA account. The client may elect to invest at monthly or quarterly
intervals and may elect either to invest a fixed dollar amount (minimum $100 per
period) or to purchase a fixed number of shares. A client can elect to have Plan
purchases executed on the first or fifteenth day of the month. Settlement occurs
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 both low
and high 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:
o monthly Premier account statements that itemize all account
activity, including investment transactions, checking activity and
Gold MasterCard(Registered) transactions during the period, and
provide unrealized and realized gain and loss estimates for most
securities held in the account;
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o comprehensive year-end summary statements that provide information
on account activity for use in tax planning and tax return
preparation;
o automatic "sweep" of uninvested cash into the RMA accountholder's
choice of one 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. An investment in a money
market fund is not insured or guaranteed by the Federal Deposit
Insurance Corporation or any other government agency. Although a
money market fund seeks to preserve the value of your investment at
$1.00 per share, it is possible to lose money by investing in a
money market fund.
o 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;
o 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;
o 24-hour access to account information through toll-free numbers, and
more detailed personal assistance during business hours from the RMA
Service Center;
o expanded account protection to $100 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 PFPC and not through PaineWebber; and
o automatic direct deposit of checks into your 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 a fund will automatically convert to Class A shares of
that fund, based on the relative net asset values per share of the two classes,
as of the close of business on the first Business Day (as defined under
"Valuation of Shares") of the month in which the sixth anniversary of the
initial issuance of such Class B shares occurs. For the purpose of calculating
the holding period required for conversion of Class B shares, the date of
initial issuance shall mean (i) the date on which such Class B shares were
issued or (ii) for Class B shares obtained through an exchange, or a series of
exchanges, the date on which the original Class B shares were issued. For
purposes of conversion to Class A shares, Class B shares purchased through the
reinvestment of dividends and other distributions paid in respect of Class B
shares will be held in a separate sub-account. Each time any Class B shares in
the shareholder's regular account (other than those in the sub-account) convert
to Class A shares, a pro rata portion of the Class B shares in the sub-account
will also convert to Class A shares. The portion will be determined by the ratio
that the shareholder's Class B shares converting to Class A shares bears to the
shareholder's total Class B shares not acquired through dividends and other
distributions.
The 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 that the conversion of shares does not constitute
a taxable event. If the conversion feature ceased to be available, the Class B
shares would not be converted and would continue to be subject to the higher
ongoing expenses of the Class B shares beyond six years from the date of
purchase. Mitchell Hutchins has no reason to believe that this condition will
not continue to be met.
VALUATION OF SHARES
Each fund determines its net asset value per share separately for each
class of shares, normally as of the close of regular trading (usually 4:00 p.m.,
Eastern time) on the New York Stock Exchange on each Business Day, which is
defined as each Monday through Friday when the New York Stock Exchange is open.
Prices will be calculated earlier when the New York Stock Exchange closes early
because trading has been halted for the day. Currently the New York Stock
Exchange is closed on the observance of the following holidays: New Year's Day,
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Martin Luther King, Jr. Day, Presidents' Day, Good Friday, Memorial Day,
Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
Securities that are listed on U.S. and foreign stock exchanges normally
are valued at the last sale price on the day the securities are 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 or (for Low Duration
Fund) the sub-adviser as the primary market. Securities traded in the
over-the-counter market and listed on the Nasdaq Stock Market ("Nasdaq")
normally are valued at the last available sale price on Nasdaq prior to
valuation; other over-the-counter 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 those
quotations adequately reflect, in the judgment of Mitchell Hutchins or the
sub-adviser, the fair value of the security. Where those 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 and other
assets are valued at fair value as determined in good faith by or under the
direction of the applicable board. It should be recognized that judgment often
plays a greater role in valuing thinly traded securities, including many lower
rated bonds, than is the case with respect to securities for which a broader
range of dealer quotations and last-sale information is available. The amortized
cost method of valuation generally is used to value debt obligations with 60
days or less remaining until maturity, unless the applicable board determines
that this does not represent fair value.
All investments quoted in foreign currency will be valued daily in U.S.
dollars on the basis of the current foreign currency exchange rate. Foreign
currency exchange rates are generally determined prior to the close of regular
trading on the New York Stock Exchange. 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 New York Stock Exchange,
which events would not be reflected in the computation of a fund's net asset
value on that day. If events materially affecting the value of such investments
or currency exchange rates occur during such time period, the investments will
be valued at their fair value as determined in good faith by or under the
direction of the applicable board. The foreign currency exchange transactions of
the funds 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.
Under normal market conditions this rate differs from the prevailing exchange
rate by less than one-tenth of one percent due to the costs of converting from
one currency to another.
PERFORMANCE INFORMATION
The funds' performance data quoted in advertising and other promotional
materials ("Performance Advertisements") represent past performance and are not
intended to indicate future performance. The investment return and principal
value of an investment will fluctuate so that an investor's shares, when
redeemed, may be worth more or less than their original cost.
TOTAL RETURN CALCULATIONS. Average annual total return quotes
("Standardized Return") used in each fund's Performance Advertisements are
calculated according to the following formula:
n
P(1 + T) = 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 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 4.0% sales charge (3.0% for Low Duration 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 or Class C
shares held for the period is deducted. All dividends and other distributions
are assumed to have been reinvested at net asset value.
The funds also may refer in Performance Advertisements to total return
performance data that are not calculated according to the formula set forth
above ("Non-Standardized Return"). The funds calculate 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
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the ending value and by dividing the remainder by the initial value. Neither
initial nor contingent deferred sales charges are taken into account in
calculating Non-Standardized Return; the inclusion of those charges would reduce
the return.
Both Standardized Return and Non-Standardized Return for Class B shares
for periods of over six years reflect conversion of the Class B shares to Class
A shares at the end of the sixth year.
The following tables show performance information for each class of the
funds' shares outstanding for the periods indicated. All returns for periods of
more than one year are expressed as an average annual return.
U.S. GOVERNMENT INCOME FUND
CLASS A CLASS B CLASS C CLASS Y
------- ------- ------- -------
Year ended November 30, 1998:
Standardized Return*........ 4.72% 3.16% 7.75% 9.41%
Non-Standardized Return..... 9.06% 8.16% 8.50% 9.41%
Five Years ended November 30, 1998:
Standardized Return*........ 3.77% 3.50% 4.10% 4.94%
Non-Standardized Return..... 4.63% 3.82% 4.10% 4.94%
Ten Years ended November 30, 1998
Standardized Return........ 6.74% N/A N/A N/A
Non-Standardized Return.... 7.18% N/A N/A N/A
Inception** to November 30, 1998:
Standardized Return*........ 7.85% 5.46% 4.33% 5.94%
Non-Standardized Return..... 8.16% 5.46% 4.33% 5.94%
LOW DURATION FUND
CLASS A CLASS B CLASS C CLASS Y
------- ------- ------- -------
Year ended November 30, 1998:
Standardized Return*........ 3.07% 2.24% 4.71% 6.37%
Non-Standardized Return..... 6.11% 5.24% 5.46% 6.37%
Five Years ended November 30, 1998:
Standardized Return*........ 4.21% 4.02% 4.29% N/A
Non-Standardized Return..... 4.88% 4.02% 4.29% N/A
Inception** to November 30, 1998:
Standardized Return*........ 4.12% 3.87% 4.13% 6.66%
Non-Standardized Return..... 4.70% 3.87% 4.13% 6.66%
INVESTMENT GRADE INCOME FUND
CLASS A CLASS B CLASS C CLASS Y
------- ------- ------- -------
Year ended November 30, 1998:
Standardized Return*........ 2.14% 0.58% 5.09% N/A
Non-Standardized Return..... 6.37% 5.56% 5.84% N/A
Five Years ended November 30, 1998:
Standardized Return*........ 5.94% 5.72% 6.29% N/A
Non-Standardized Return..... 6.80% 6.03% 6.29% N/A
Ten Years ended November 30, 1998
Standardized Return......... 8.81% N/A N/A N/A
Non-Standardized Return..... 9.26% N/A N/A N/A
Inception** to November 30, 1998:
Standardized Return*........ 9.57% 8.24% 7.28% 3.51%
Non-Standardized Return..... 9.88% 8.24% 7.28% 3.51%
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HIGH INCOME FUND
CLASS A CLASS B CLASS C CLASS Y
------- ------- ------- -------
Year ended November 30, 1998:
Standardized Return*........ (8.30)% (9.68)% (5.58)% N/A
Non-Standardized Return..... (4.46)% (5.32)% (4.92)% N/A
Five Years ended November 30, 1998:
Standardized Return*........ 3.76% 3.55% 4.08% N/A
Non-Standardized Return..... 4.60% 3.82% 4.08% N/A
Ten Years ended November 30, 1998
Standardized Return......... 9.02% N/A N/A N/A
Non-Standardized Return..... 9.46% N/A N/A N/A
Inception** to November 30, 1998:
Standardized Return*........ 9.73% 10.00% 7.28% (8.43)%
Non-Standardized Return..... 10.05% 10.00% 7.28% (8.43)%
STRATEGIC INCOME FUND
CLASS A CLASS B CLASS C CLASS Y
------- ------- ------- -------
Year ended November 30, 1998:
Standardized Return*........ (2.41)% (3.85)% 0.43% N/A
Non-Standardized Return..... 1.65% 0.87% 1.14% N/A
Inception** to November 30, 1998:
Standardized Return*........ 5.10% 4.90% 5.47% (1.04)%
Non-Standardized Return..... 6.00% 5.21% 5.47% (1.04)%
- --------------
* All Standardized Return figures for Class A shares reflect deduction of the
current maximum sales charge of 4.0% (3.0% for Low Duration 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. Class Y shares do not impose an initial or
contingent deferred sales charge; therefore, the performance information is
the same for both standardized return and non-standardized return for the
periods indicated.
** The inception date for each class of shares is as follows:
Class A Class B Class C Class Y
------- ------- ------- -------
U.S. Government Income Fund 08/31/84 07/01/91 07/02/92 09/11/91
Low Duration Fund 05/03/93 05/03/93 05/03/93 10/20/95
Investment Grade Income Fund 08/31/84 07/01/91 07/02/92 02/20/98
High Income Fund 08/31/84 07/01/91 07/02/92 02/20/98
Strategic Income Fund 02/07/94 02/07/94 02/07/94 02/17/98
YIELD. Yields used in each fund's Performance Advertisements are
calculated by dividing the fund's interest income attributable to a class of
shares for a 30-day period ("Period"), net of expenses attributable to such
class, by the average number of shares of such class entitled to receive
dividends during the Period and expressing the result as an annualized
percentage (assuming semi-annual compounding) of the 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:
YIELD = [OBJECT OMITTED]
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)
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c= the average daily number of shares of a class outstanding
during the Period that were entitled to receive dividends
d= the maximum offering price per share (in the case of Class A
shares) or the net asset value per share (in the case of
Class B and Class C shares) on the last day of the Period.
Except as noted below, in determining interest 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 totaling the interest
earned on all debt obligations. For purposes of these calculations, the maturity
of an obligation with one or more call provisions is assumed to be the next date
on which the obligation reasonably can be expected to be called or, if none, the
maturity date. With respect to Class A shares, in calculating the maximum
offering price per share at the end of the Period (variable "d" in the above
formula) the fund's current maximum 4.0% (3.0% for Low Duration Fund) initial
sales charge on Class A shares is included.
The following table shows the yield for each class of shares of each fund
for the 30-day period ended November 30, 1998:
<TABLE>
<CAPTION>
U.S. Government Low Duration Investment Grade High Income Strategic Income
Income Fund Fund Income Fund Fund Fund
----------- ---- ----------- ---- ----
<S> <C> <C> <C> <C> <C>
Class A.......... 4.59% 5.17% 5.61% 10.52% 6.70%
Class B.......... 3.93% 4.50% 5.09% 10.22% 6.21%
Class C.......... 4.32% 4.68% 5.36% 10.46% 6.48%
Class Y.......... 5.11% 5.58% 6.13% 11.20% 7.26%
</TABLE>
OTHER INFORMATION. In Performance Advertisements, the funds may compare
their Standardized Return and/or their Non-Standardized Return with data
published by Lipper Inc. ("Lipper") for U.S. government funds (U.S. Government
Income Fund and Low Duration 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 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 ("S&P 500"), the Dow Jones
Industrial Average, and changes in the Consumer Price Index as published by the
U.S. Department of Commerce. These comparisons also may include economic data
and statistics published by the U.S. 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 these 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 THE WALL STREET JOURNAL, MONEY
Magazine, FORBES, BUSINESS WEEK, FINANCIAL WORLD, BARRON'S, FORTUNE, THE NEW
YORK TIMES, THE CHICAGO TRIBUNE, THE WASHINGTON POST and THE KIPLINGER LETTERS.
Comparisons in Performance Advertisements may be in graphic form.
The funds may include discussions or illustrations of the effects of
compounding in Performance Advertisements. "Compounding" refers to the fact
that, if dividends or other distributions on a fund investment are reinvested in
additional fund shares, any future income or capital appreciation of a 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 a 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 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 the funds'
53
<PAGE>
performance to CD performance, investors should keep in mind that bank CDs are
insured in whole or in part by an agency of the U.S. government and offer fixed
principal and fixed or variable rates of interest, and that bank CD yields may
vary depending on the financial institution offering the CD and prevailing
interest rates. Shares of the funds are not insured or guaranteed by the U.S.
government and returns and net asset values will fluctuate. The debt securities
held by the funds generally have longer maturities than most CDs and may reflect
interest rate fluctuations for longer term debt securities. An investment in any
fund involves greater risks than an investment in either a money market fund or
a CD.
TAXES
BACKUP WITHHOLDING. Each fund is required to withhold 31% of all
dividends, capital gain distributions and redemption proceeds payable to
individuals and certain other non-corporate shareholders who do not provide the
fund or PaineWebber with a correct taxpayer identification number. Withholding
at that rate also is required from dividends and capital gain distributions
payable to those shareholders who otherwise are subject to backup withholding.
SALE OR EXCHANGE OF FUND SHARES. A shareholder's sale (redemption) of
shares may result in a taxable gain or loss, depending on whether the
shareholder receives more or less than his or her adjusted basis for the shares
(which normally includes any initial sales charge paid on Class A shares). An
exchange of any fund's shares for shares of another PaineWebber mutual fund
generally will have similar tax consequences. In addition, if a fund's shares
are bought within 30 days before or after selling other shares of the fund
(regardless of class) at a loss, all or a portion of that loss will not be
deductible and will increase the basis of the newly purchased shares.
SPECIAL RULE FOR CLASS A SHAREHOLDERS. A special tax rule applies when a
shareholder sells or exchanges Class A shares within 90 days of purchase and
subsequently acquires Class A shares of the same or another PaineWebber mutual
fund without paying a sales charge due to the 365-day reinstatement privilege or
the exchange privilege. In these cases, any gain on the sale or exchange of the
original Class A shares would be increased, or any loss would be decreased, by
the amount of the sales charge paid when those shares were bought, and that
amount would increase the basis of the PaineWebber mutual fund shares
subsequently acquired.
CONVERSION OF CLASS B SHARES. A shareholder will recognize no gain or loss
as a result of a conversion from Class B shares to Class A shares.
QUALIFICATION AS A REGULATED INVESTMENT COMPANY. To qualify for treatment
as a RIC under the Internal Revenue Code, a 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 gains and net gains from certain foreign currency transactions)
("Distribution Requirement") and must meet several additional requirements. For
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 contracts) derived with respect to its
business of investing in securities or those currencies ("Income Requirement");
(2) at the close of each quarter of the fund's taxable year, at least 50% of the
value of its total assets must be represented by cash and cash items, U.S.
government securities, securities of other RICs and other securities, with these
other securities limited, in respect of any one issuer, to an amount that does
not exceed 5% of the value of the fund's total assets and that does not
represent more than 10% of the issuer's outstanding voting securities; and (3)
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. If any
fund failed to qualify for treatment as a RIC for any taxable year, (a) it would
be taxed as an ordinary corporation on the full amount of its taxable income for
that year without being able to deduct the distributions it makes to its
shareholders and (b) the shareholders would treat all those distributions,
including distributions of net capital gain (i.e., the excess of net long-term
capital gain over net short-term capital loss), as dividends (that is, ordinary
income) to the extent of the fund's earnings and profits. In addition, the fund
could be required to recognize unrealized gains, pay substantial taxes and
interest, and make substantial distributions before requalifying for RIC
treatment.
OTHER INFORMATION. Dividends and other distributions declared by a fund in
October, November or December of any year and payable to shareholders of record
on a date in any of those months will be deemed to have been paid by the fund
and received by the shareholders on December 31 of that year if the
distributions are paid by the fund during the following January. Accordingly,
those distributions will be taxed to shareholders for the year in which that
December 31 falls.
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U.S. Government Income Fund and Low Duration 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 Investment Grade
Income Fund, High Income Fund and Strategic Income Fund are authorized to hold
equity securities, it is expected that any dividend income received by these
funds will be minimal.
If shares of a fund are sold at a loss after being held for six months or
less, the loss will be treated as long-term, instead of short-term, capital loss
to the extent of any capital gain distributions received on those shares.
Investors also should be aware that if shares are purchased shortly before the
record date for any dividend or capital gain distribution, the shareholder will
pay full price for the shares and receive some portion of the price back as a
taxable distribution.
Each fund will be subject to a nondeductible 4% excise tax ("Excise Tax")
to the extent it fails to distribute by the end of any calendar year
substantially all of its ordinary income for that year and capital gain net
income for the one-year period ending on November 30 of that year, plus certain
other amounts.
Dividends and interest received, and gains realized, by a fund on foreign
securities may be subject to income, withholding or other taxes imposed by
foreign countries and U.S. possessions (collectively "foreign taxes") that would
reduce the return on its securities. Tax conventions between certain countries
and the United States, however, may reduce or eliminate foreign taxes, and many
foreign countries do not impose taxes on capital gains in respect of investments
by foreign investors. If more than 50% of the value of Strategic Income Fund's
total assets at the close of its taxable year consists of securities of foreign
corporations, it will be eligible to, and may, file an election with the
Internal Revenue Service that will enable its shareholders, in effect, to
receive the benefit of the foreign tax credit with respect to any foreign taxes
it paid. Pursuant to the election, the fund would treat those taxes as dividends
paid to its shareholders and each shareholder (1) would be required to include
in gross income, and treat as paid by him or her, his or her proportionate share
of those taxes, (2) would be required to treat his or her share of those taxes
and of any dividend paid by the fund that represents income from foreign or U.S.
possessions sources as his or her own income from those sources, and (3) could
either deduct the foreign taxes deemed paid by him or her in computing his or
her taxable income or, alternatively, use the foregoing information in
calculating the foreign tax credit against his or her federal income tax. If
Strategic Income Fund makes this election, it will report to its shareholders
shortly after each taxable year their respective shares of foreign taxes paid
and the income from sources within, and taxes paid to, foreign countries and
U.S. possessions. Individuals who have no more than $300 ($600 for married
persons filing jointly) of creditable foreign taxes included on Forms 1099 and
all of whose foreign source income is "qualified passive income" may elect each
year to be exempt from the extremely complicated foreign tax credit limitation,
in which event they would be able to claim a foreign tax credit without having
to file the detailed Form 1116 that otherwise is required.
The use of hedging strategies, such as writing (selling) and purchasing
options and futures contracts and entering into forward currency contracts,
involves complex rules that will determine for income tax purposes the amount,
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 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.
If a fund has an "appreciated financial position"--generally, an interest
(including an interest through an option, futures or forward currency contract
or short sale) with respect to any stock, debt instrument (other than "straight
debt") or partnership interest the fair market value of which exceeds its
adjusted basis--and enters into a "constructive sale" of the same or
substantially similar property, the fund will be treated as having made an
actual sale thereof, with the result that gain will be recognized at that time.
A constructive sale generally consists of a short sale, an offsetting notional
principal contract or a futures or forward currency contract entered into by a
fund or a related person with respect to the same or substantially similar
property. In addition, if the appreciated financial position is itself a short
sale or such a contract, acquisition of the underlying property or substantially
similar property will be deemed a constructive sale. The foregoing will not
apply, however, to a fund's transaction during any taxable year that otherwise
would be treated as a constructive sale if the transaction is closed within 30
days after the end of that year and the fund holds the appreciated financial
position unhedged for 60 days after that closing (i.e., at no time during that
60-day period is the fund's risk of loss regarding that position reduced by
reason of certain specified transactions with respect to substantially similar
or related property, such as having an option to sell, being contractually
obligated to sell, making a short sale or granting an option to buy
substantially identical stock or securities).
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<PAGE>
A fund may acquire (1) zero coupon or other securities issued with
original issue discount ("OID") or (2) Treasury inflation-protected securities
("TIPS"), on which principal is adjusted based on changes in the Consumer Price
Index. A fund must include in its gross income the portion of the OID that
accrues on those securities, and the amount of any principal increases on TIPS
during the taxable year, even if the fund receives no corresponding payment on
them during the year. Similarly, Investment Grade Income Fund, High Income Fund
and Strategic Income Fund each must include in its gross income securities it
receives as "interest" on payment-in-kind securities. Each fund has elected
similar treatment with respect to securities purchased at a discount from their
face value ("market discount"). Because a 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, it might 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
would have to be made from the fund's cash assets or from the proceeds of sales
of portfolio securities, if necessary. The fund might realize capital gains or
losses from those sales, which would increase or decrease its investment company
taxable income and/or net capital gain.
OTHER INFORMATION
MASSACHUSETTS BUSINESS TRUSTS. Each Trust is an entity of the type
commonly known as a "Massachusetts business trust." Under Massachusetts law,
shareholders of a fund could, under certain circumstances, be held personally
liable for the obligations of the fund or its Trust. However, each Trust's
Declaration of Trust disclaims shareholder liability for acts or obligations of
the Trust or the fund and requires that notice of such disclaimer be given in
each note, bond, contract, instrument, certificate or undertaking made or issued
by the board members or by any officers or officer by or on behalf of the Trust
or the fund, the board members 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 incurring
financial loss on account of shareholder liability is limited to circumstances
in which the fund itself would be unable to meet its obligations, a possibility
that Mitchell Hutchins believes is remote and not material. Upon payment of any
liability incurred by a shareholder solely by reason of being or having been a
shareholder, the shareholder paying such liability would be entitled to
reimbursement from the general assets of the relevant fund. The board members
intend to conduct each fund's operations in such a way as to avoid, as far as
possible, ultimate liability of the shareholders for liabilities of the fund.
CLASSES OF SHARES. A share of each class of a fund represents an identical
interest in that fund's investment portfolio and has the same rights, privileges
and preferences. However, each class may differ with respect to sales charges,
if any, distribution and/or service fees, if any, other expenses allocable
exclusively to each class, voting rights on matters exclusively affecting that
class, and its exchange privilege, if any. The different sales charges and other
expenses applicable to the different classes of shares of the funds will affect
the performance of those classes. Each share of a fund is entitled to
participate equally in dividends, other distributions and the proceeds of any
liquidation of that fund. However, due to the differing expenses of the classes,
dividends and liquidation proceeds on Class A, B, C and Y shares will differ.
VOTING RIGHTS. Shareholders of each fund are entitled to one vote for each
full share held and fractional votes for fractional shares held. Voting rights
are not cumulative and, as a result, the holders of more than 50% of all the
shares of a Trust may elect all of the board members of that Trust. The shares
of a fund will be voted together, except that only the shareholders of a
particular class of a fund may vote on matters affecting only that class, such
as the terms of a Rule 12b-1 Plan as it relates to the class. The shares of each
series of Managed Trust and Securities Trust will be voted separately, except
when an aggregate vote of all the series is required by law.
The funds do not hold annual meetings. Shareholders of record of no less
than two-thirds of the outstanding shares of a Trust may remove a board member
through a declaration in writing or by vote cast in person or by proxy at a
meeting called for that purpose. A meeting will be called to vote on the removal
of a board member at the written request of holders of 10% of the outstanding
shares of a Trust.
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CLASS-SPECIFIC EXPENSES. Each fund may determine to allocate certain of
its expenses (in addition to service and distribution fees) to the specific
classes of its shares to which those expenses are attributable. For example,
Class B and Class C shares bear higher transfer agency fees per shareholder
account than those borne by Class A or Class Y 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. 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.
56a
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PRIOR NAMES. Prior to October 20, 1995, Low Duration Fund was known as
"PaineWebber Short-Term U.S. Government Income Fund." Prior to November 10,
1995, the Class C shares of all the funds were called "Class D" shares, and the
Class Y shares of U.S. Government Income Fund and Low Duration Fund were called
"Class C" shares.
CUSTODIAN AND RECORDKEEPING AGENT; TRANSFER AND DIVIDEND AGENT. State
Street Bank and Trust Company, located at One Heritage Drive, North Quincy,
Massachusetts 02171, serves as custodian and recordkeeping agent for each fund
and employs foreign sub-custodians approved by the respective boards in
accordance with applicable requirements under the 1940 Act to provide custody of
the funds' foreign assets. PFPC Inc., a subsidiary of PNC Bank, N.A., serves as
each fund's transfer and dividend disbursing agent. It is located at 400
Bellevue Parkway, Wilmington, DE 19809.
COMBINED PROSPECTUS. Although each fund is offering only its own shares,
it is possible that a fund might become liable for a misstatement in the
Prospectus about another fund. The board of each fund has considered this factor
in approving the use of a single, combined Prospectus.
COUNSEL. The law firm of Kirkpatrick & Lockhart LLP, 1800 Massachusetts
Avenue, N.W., Washington, D.C. 20036-1800, serves as counsel to the funds.
Kirkpatrick & Lockhart LLP also acts as counsel to PaineWebber and Mitchell
Hutchins in connection with other matters.
AUDITORS. Ernst & Young LLP, 787 Seventh Avenue, New York, New York 10019,
serves as independent auditors for U.S. Government Income Fund, Low Duration
Fund, Investment Grade Income Fund and High Income Fund. PricewaterhouseCoopers
LLP, 1177 Avenue of the Americas, New York, New York 10036, serves as
independent accountants for Strategic Income Fund.
FINANCIAL STATEMENTS
Each fund's Annual Report to Shareholders for its last fiscal year ended
November 30, 1998 is a separate document supplied with this Statement of
Additional Information, and the financial statements, accompanying notes and
report of independent auditors or independent accountants appearing therein are
incorporated herein by this reference.
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APPENDIX
RATINGS INFORMATION
DESCRIPTION OF MOODY'S CORPORATE BOND RATINGS
Aaa. Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt edged." Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements are
likely to change, such changes as can be visualized are most unlikely to impair
the fundamentally strong position of such issues; Aa. Bonds which are rated Aa
are judged to be of high quality by all standards. Together with the Aaa group
they comprise what are generally known as high grade bonds. They are rated lower
than the best bonds because margins of protection may not be as large as in Aaa
securities or fluctuation of protective elements may be of greater amplitude or
there may be other elements present which make the long term risk appear
somewhat larger than in Aaa securities; A. Bonds which are rated A possess many
favorable investment attributes and are to be considered as upper-medium-grade
obligations. Factors giving security to principal and interest are considered
adequate, but elements may be present which suggest a susceptibility to
impairment sometime in the future; Baa. Bonds which are rated Baa are considered
as medium-grade obligations, i.e., they are neither highly protected nor poorly
secured. Interest payment and principal security appear adequate for the present
but certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well; Ba. Bonds
which are rated Ba are judged to have speculative elements; their future cannot
be considered as well-assured. Often the protection of interest and principal
payments may be very moderate and thereby not well safeguarded during both good
and bad times over the future. Uncertainty of position characterizes bonds in
this class; B. Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time may be
small; Caa. Bonds which are rated Caa are of poor standing. Such issues may be
in default or there may be present elements of danger with respect to principal
or interest; Ca. Bonds which are rated Ca represent obligations which are
speculative in a high degree. Such issues are often in default or have other
marked shortcomings; C. Bonds which are rated C are the lowest rated class of
bonds, and issues so rated can be regarded as having extremely poor prospects of
ever attaining any real investment standing.
Note: Moody's applies numerical modifiers, 1, 2 and 3 in each generic
rating classification from Aa through Caa. The modifier 1 indicates that the
obligation ranks in the higher end of its generic rating category, the modifier
2 indicates a mid-range ranking, and the modifier 3 indicates a ranking in the
lower end of that generic rating category.
DESCRIPTION OF S&P CORPORATE DEBT RATINGS
AAA. An obligation rated AAA has the highest rating assigned by S&P. The
obligor's capacity to meet its financial commitment on the obligation is
extremely strong; AA. An obligation rated AA differs from the highest rated
obligations only in small degree. The obligor's capacity to meet its financial
commitment on the obligation is very strong; A. An obligation rated A is
somewhat more susceptible to the adverse effects of changes in circumstances and
economic conditions than obligations in higher rated categories. However, the
obligor's capacity to meet its financial commitment on the obligation is still
strong; BBB. An obligation rated BBB exhibits adequate protection parameters.
However, adverse economic conditions or changing circumstances are more likely
to lead to a weakened capacity of the obligor to meet its financial commitment
on the obligation; BB, B, CCC, CC, C, D. Obligations rated BB, B, CCC, CC and C
are regarded as having significant speculative characteristics. BB indicates the
least degree of speculation and C the highest. While such obligations will
likely have some quality and protective characteristics, these may be outweighed
by large uncertainties or major exposures to adverse conditions; BB. An
obligation rated BB is less vulnerable to nonpayment than other speculative
issues. However, it faces major ongoing uncertainties or exposure to adverse
business, financial, or economic conditions which could lead to the obligor's
inadequate capacity to meet its financial commitment on the obligation; B. An
obligation rated B is more vulnerable to nonpayment than obligations rated BB,
but the obligor currently has the capacity to meet its financial commitment on
the obligation. Adverse business, financial, or economic conditions will likely
impair the obligor's capacity or willingness to meet its financial commitment on
the obligation; CCC. An obligation rated CCC is currently vulnerable to
nonpayment and is dependent upon favorable business, financial and economic
conditions for the obligor to meet its financial commitment on the obligation.
In the event of adverse business, financial, or economic conditions, the obligor
is not likely to have the capacity to meet its financial commitment on the
obligation; CC. An obligation rated CC is currently highly vulnerable to
nonpayment; C. The C rating may be used to cover a situation where a bankruptcy
petition has been filed or similar action has been taken, but payments on this
obligation are being continued; D. An obligation rated D is in payment default.
The D rating category is used when payments on an obligation are not made on the
date due even if the applicable grace period has not expired, unless S&P
believes that such payments will be made during such grace period. The D rating
also will be used upon the filing of a bankruptcy petition or the taking of a
similar action if payments on an obligation are jeopardized.
A-1
<PAGE>
CI. The rating CI is reserved for income bonds on which no interest is
being paid.
Plus (+) or Minus (-): The ratings from "AA" to "CCC" may be modified by
the addition of a plus or minus sign to show relative standing within the major
rating categories.
r. This symbol is attached to the ratings of instruments with significant
noncredit risks. It highlights risks to principal or volatility of expected
returns which are not addressed in the credit rating. Examples include:
obligations linked or indexed to equities, currencies, or commodities;
obligations exposed to severe prepayment risk--such as interest-only or
principal-only mortgage securities; and obligations with unusually risky
interest terms, such as inverse floaters.
DESCRIPTION OF MOODY'S COMMERCIAL PAPER RATINGS
PRIME-1. Issuers assigned this highest rating have a superior ability for
repayment of senior short-term debt obligations. Prime-1 repayment ability will
often be evidenced by the following characteristics: Leading market positions in
well established industries; high rates of return on funds employed;
conservative capitalization structures with moderate reliance on debt and ample
asset protection; broad margins in earnings coverage of fixed financial charges
and high internal cash generation; well established access to a range of
financial markets and assured sources of alternate liquidity.
PRIME-2. Issuers assigned this rating have a strong ability for repayment
of senior short-term debt obligations. This will normally be evidenced by many
of the characteristics cited above, but to a lesser degree. Earnings trends and
coverage ratios, while sound, will be more subject to variation. Capitalization
characteristics, while still appropriate, may be more affected by external
conditions. Ample alternate liquidity is maintained.
PRIME-3. Issuers assigned this rating have an acceptable capacity for
repayment of senior short-term obligations. The effect of industry
characteristics and market composition may be more pronounced. Variability in
earnings and profitability may result in changes in the level of debt protection
measurements and may require relatively high financial leverage. Adequate
alternate liquidity is maintained.
NOT PRIME. Issuers assigned this rating do not fall within any of the
Prime rating categories.
DESCRIPTION OF S&P COMMERCIAL PAPER RATINGS
A-1. A short-term obligation rated A-1 is rated in the highest category by
S&P. The obligor's capacity to meet its financial commitment on the obligation
is strong. Within this category, certain obligations are designated with a plus
sign (+). This indicates that the obligor's capacity to meet its financial
commitment on these obligations is extremely strong. A-2. A short-term
obligation rated A-2 is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than obligations in higher
rating categories. However, the obligor's capacity to meet its financial
commitment on the obligation is satisfactory. A-3. A short-term obligation rated
A-3 exhibits adequate protection parameters. However, adverse economic
conditions or changing circumstances are more likely to lead to a weakened
capacity of the obligor to meet its financial commitment on the obligation. B. A
short-term obligation rated B is regarded as having significant speculative
characteristics. The obligor currently has the capacity to meet its financial
commitment on the obligation; however, it faces major ongoing uncertainties
which could lead to the obligor's inadequate capacity to meet its financial
commitments on the obligation. C. A short-term obligation rated C is currently
vulnerable to nonpayment and is dependent upon favorable business, financial and
economic conditions for the obligor to meet its financial commitment on the
obligation. D. A short-term obligation rated D is in payment default. The D
rating category is used when payments on an obligation are not made on the date
due even if the applicable grace period has not expired, unless S&P believes
that such payments will be made during such grace period. The D rating also will
be used upon the filing of a bankruptcy petition or the taking of a similar
action if payments on an obligation are jeopardized.
A-2
<PAGE>
YOU SHOULD RELY ONLY ON THE INFORMATION
CONTAINED OR REFERRED TO IN THE PaineWebber
PROSPECTUS AND THIS STATEMENT OF U.S. Government Income Fund
ADDITIONAL INFORMATION. THE FUNDS AND
THEIR DISTRIBUTOR HAVE NOT AUTHORIZED PaineWebber
ANYONE TO PROVIDE YOU WITH INFORMATION Low Duration U.S. Government
THAT IS DIFFERENT. THE PROSPECTUS AND Income Fund
THIS STATEMENT OF ADDITIONAL INFORMATION
IS NOT AN OFFER TO SELL SHARES OF THE PaineWebber
FUNDS IN ANY JURISDICTION WHERE THE Investment Grade Income Fund
FUNDS OR THEIR DISTRIBUTOR MAY NOT
LAWFULLY SELL THOSE SHARES. PaineWebber
High Income Fund
------------
PaineWebber
Strategic Income Fund
TABLE OF CONTENTS
PAGE
----
The Funds and Their Investment
Policies......................... 1
The Funds' Investments, Related
Risks and Limitations............ 4
Strategies Using Derivative
Instruments...................... 22
Organization of the Trusts;
Trustees and Officers and
Principal Holders of Securities.. 29 ------------------------------------
Investment Advisory and Statement of Additional Information
Distribution Arrangements........ 35 March 31, 1999
Portfolio Transactions........... 43 ------------------------------------
Reduced Sales Charges, Additional
Exchange and Redemption Information
and Other Services............... 45
Conversion of Class B Shares..... 49
Valuation of Shares.............. 49
Performance Information.......... 50
Taxes............................ 54
Other Information................ 56
Appendix......................... A-1
PAINEWEBBER
(COPYRIGHT)1999 PaineWebber Incorporated
