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PROSPECTUS
SEPTEMBER 1, 1999
EXETER FUND, INC.
PUREMARK-SM- SERIES
CLASS A SHARES
The Securities and Exchange Commission has not approved or disapproved these
securities or determined whether this prospectus is accurate or complete.
Any statement to the contrary is a crime.
[LOGO]
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EXETER FUND, INC.
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P.O. BOX 41118
ROCHESTER, NEW YORK 14604
716-325-6880 800-466-3863
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Exeter Asset Management is a division of Manning & Napier Advisors, Inc.,
which was founded in 1970 and manages over $7 billion for individual and
institutional investors.
CONTENTS PAGE
Goals, Strategies, and Risks 4
More About the Series' Investments 6
Management 7
How to Buy, Exchange, and Redeem Shares 8
Investment and Account Information 10
Dividends, Distributions, and Taxes 11
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GOALS, STRATEGIES, AND RISKS
INVESTMENT GOAL
Provide long-term total return that is consistent with the broad U.S. stock
market, as represented by the Russell 3000-Registered Trademark- Index,
through investments that meet the socially responsible criteria of the Series.
INVESTMENT STRATEGIES
The Series invests primarily in the common stocks of companies represented in
the Russell 3000-Registered Trademark- Index. The Advisor seeks to avoid the
common stocks of companies failing to satisfy certain "socially responsible"
investment criteria. After these companies have been removed from the stocks
in the index, the Advisor builds a portfolio of approximately 250 - 300
stocks that has market-sector and risk characteristics that are similar to
the index. With this approach, the Advisor attempts to approximate the return
and volatility of the index. The Advisor periodically rebalances the Series'
portfolio to keep its weightings in line with those of the index.
THE RUSSELL 3000-Registered Trademark- INDEX MEASURES THE PERFORMANCE OF THE
3,000 LARGEST U.S. COMPANIES BASED ON TOTAL MARKET CAPITALIZATION.
SOCIALLY RESPONSIBLE INVESTMENT CRITERIA The screening process is designed to
avoid investments in companies that the Advisor believes derive a significant
portion of their revenue from the following businesses:
- Tobacco
- Alcohol
- Pornography
- Gambling
- Drugs or devices primarily used for abortion
The Advisor uses a variety of outside sources and conducts its own research in
determining which stocks meet the Series' selection criteria.
PRINCIPAL RISKS OF INVESTING IN THE SERIES
As with any stock fund, the value of your investment will fluctuate in
response to stock market movements. You could lose money on your investment
in the Series or the Series could underperform if any of the following occurs:
- The U.S. stock markets go down.
- An adverse event, such as an unfavorable earnings report, depresses the
value of one or more of the Series' portfolio holdings.
There are additional risks associated with the specific investment approach used
in the management of this Series:
- The Advisor will not be able to respond to a decline in the index
by temporarily moving assets to investments not correlated with
the index.
- Because certain types of companies are eliminated from the portfolio,
the Series may not track the index as well as a true index fund.
- The Series will incur expenses, such as advisory fees, trading and
custody costs that do not apply to an index.
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SUMMARY OF PAST PERFORMANCE
This Series was not active as of the date of this prospectus; therefore, no
performance information is provided.
WHO MAY WANT TO INVEST
The Series may be an appropriate investment if you:
- Are seeking a socially responsible investment.
- Are seeking a mutual fund for the equity portion of an asset allocation
portfolio.
- Have a long-term time horizon for your investment and are willing and
able to accept the risk of short-term stock market swings.
- Are willing to accept a potentially lower total return than might be
possible if certain categories of stocks were not eliminated from
consideration for the Series.
FEES AND EXPENSES OF THE SERIES
This table estimates the fees and expenses you may pay if you invest in shares
of the Series.
<TABLE>
<CAPTION>
PUREMARK-SM- SERIES
<S> <C>
SHAREHOLDER FEES (paid directly from your investment) None(1)
ANNUAL FUND OPERATING EXPENSES
(expenses that are deducted from assets of the Series)
Management fee 0.50%
Distribution and service (Rule 12b-1) fees None
Other expenses 0.32%
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Total annual fund operating expenses 0.82%
Less fee waivers and expense reimbursements (0.12)%(2)
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Net expenses 0.70%
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</TABLE>
(1)A wire charge, currently $15, may be deducted by the transfer agent from
the amount of a wire redemption payment made at the request of a shareholder.
A shareholder may effect up to four exchanges in a twelve-month period
without charge; subsequent exchanges are subject to a fee of $15.
(2)The Advisor has contractually agreed to limit its fees and reimburse
expenses to the extent necessary so that the Series' total annual fund
operating expenses do not exceed 0.70% of the Series' average daily net
assets. This contractual waiver will remain in effect until at least
February 29, 2000 and may be extended.
This example is intended to help you compare the cost of investing in the Series
with the cost of investing in other mutual funds.
THE EXAMPLE BELOW ASSUMES THAT:
- You invest $10,000 for the periods shown
- The Series' operating expenses remain the same
- Your investment has a 5% return each year
Although your actual costs may be higher or lower, under these assumptions your
costs would be:
After After
1 year 3 years
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$72 $224
Because the Series was not active as of the date of this prospectus, the
"Annual Fund Operating Expenses" presented are estimates based upon projections
made by the Advisor and reflect the effect of the Advisor's contractual fee
waiver. In addition, the Series has not calculated these expenses beyond the
three year period shown.
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MORE ABOUT THE SERIES' INVESTMENTS
DERIVATIVE CONTRACTS
The Series may, but is not required to, use derivative contracts as a
substitute for purchasing or selling securities contained in the index. A
derivative contract will obligate or entitle the Series to deliver or receive
an asset or a cash payment that is based on the change in value of a
designated security or index.
THE SERIES' INVESTMENT GOAL
The Series' board of directors may change the Series' investment goal (described
above under "Goals, Strategies, and Risks") without obtaining the approval of
the Series' shareholders. The Series might not succeed in achieving its goal.
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MANAGEMENT
THE ADVISOR
The Series' Advisor is Exeter Asset Management, a division of Manning & Napier
Advisors, Inc., 1100 Chase Square, Rochester, New York 14604. Manning & Napier
Advisors, Inc. was founded in 1970, and it manages over $7 billion for
individual and institutional investors. The Advisor is responsible for the
day-to-day operations of the Series and generally is responsible for supervision
of the Series' overall business affairs, service providers and officers.
A team made up of investment professionals and analysts makes all of the
Series' investment decisions.
THE DISTRIBUTOR
The distributor of the Series' shares is Manning & Napier Investor Services,
Inc. Class A shares are offered to investors who purchase shares directly
from the distributor or through certain registered investment advisors.
Class A shares are not subject to any distribution or shareholder servicing
fees. The Advisor may, from its own resources, defray or absorb costs
relating to distribution, including compensation of employees who are
involved in distribution.
MANAGEMENT FEES
In return for the services it provides to the Series, the Advisor receives a
management fee at a rate of 0.50%, which is computed daily and payable
monthly by the Series. The Advisor has contractually agreed to limit the
Series' total operating expenses to a total of 0.70%. This contractual waiver
will remain in effect until at least February 29, 2000 and may be extended.
The Advisor may use its own resources to engage in activities that may promote
the sale of the Series, including payments to third parties who provide
shareholder support servicing and distribution assistance. Investors may be
charged a fee if they effect transactions through a broker or agent.
YEAR 2000 ISSUE
Information technology experts are concerned about computer systems' ability
to process date-related information on and after January 1, 2000. This
situation, commonly known as the "Year 2000" issue, could have an adverse
impact on the Series. The cost of addressing the Year 2000 issue, if
substantial, could adversely affect companies and governments that issue
securities held by the Series. The Advisor, the transfer agent and the
distributor are addressing the Year 2000 issue for their systems. The Series
has been informed by its other service providers that they are taking similar
measures. Although the Series does not expect the Year 2000 issue to
adversely affect it, the Series cannot guarantee that the efforts of the
Series or its service providers to correct the problem will be successful.
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HOW TO BUY, EXCHANGE, AND REDEEM SHARES
HOW TO BUY SHARES
The minimum initial investment in the Series is $2,000, and the minimum for
each additional investment is $100. The minimum investment requirements are
lower for participants in the Automatic Investment Plan, which is described
below. These investment minimums may be waived at the Advisor's discretion.
All orders to purchase shares received in good order by the distributor,
transfer agent or other agent before the close of trading on the New York
Stock Exchange (NYSE), generally 4:00 pm New York time, will be executed at
that day's share price. Orders received in good order after that day's close
will be executed at the next business day's price. All orders must include
the required documentation and be accompanied by proper payment. The Series
reserves the right to reject purchase orders or to stop offering its shares
without notice to shareholders.
BY MAIL
OPENING AN ACCOUNT
- Send a check payable to Exeter Fund, Inc. with the completed original
account application.
The address is:
EXETER FUND, INC.
P.O. BOX 41118
ROCHESTER, NY 14604
- To request an account application, call the Fund at 1-800-466-3863.
ADDING TO AN ACCOUNT
- Send a check payable to Exeter Fund, Inc. and a letter of instruction
with the name of the Series to be purchased and the account name and
number.
BY WIRE
OPENING OR ADDING TO AN ACCOUNT
- After the Fund has received your completed account application, you
may wire funds to open or add shares to your account. Before sending a
wire, call 1-800-466-3863 for wire instructions.
AUTOMATIC INVESTMENT PLAN
You may participate in the Automatic Investment Plan by completing the
applicable section of the account application or contacting the Fund. Through
the plan, you can authorize transfers of a specified amount from your bank
account into the Series on a regular basis. The minimum amount of each
investment is $25. If you have insufficient funds in your account to complete
a transfer, your bank may charge you a fee.
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HOW TO EXCHANGE SHARES
You may exchange shares of a Series for shares of any other Series of the
Exeter Fund, if the registration of both accounts is identical. If received
with proper documentation before the close of trading on the NYSE, exchange
requests will be executed at that day's share prices. Otherwise, they will be
executed at the prices determined on the next business day after receipt with
proper documentation.
The minimum exchange amount is $1,000 (or all the shares in your account, if
less than $1,000). You may exchange up to 4 times during any 12-month period
without paying a sales charge or any other fee. For any additional exchanges,
you may be charged $15 per exchange. A Series may refuse any exchange order
and may alter, limit or suspend its exchange privilege on 60 days' notice. An
exchange involves a taxable redemption of shares surrendered in the exchange.
BY MAIL
- Send a letter of instruction to Exeter Fund, Inc., at the address on the
opposite page, signed by each registered account owner, exactly as your
names appear on the account registration.
- Provide the name of the current Series, Series to exchange into and
dollar amount to be exchanged.
- Provide both account numbers.
BY TELEPHONE
- Unless you have declined telephone privileges, call the Fund at
1-800-466-3863.
- Provide the name of the current Series, Series to exchange into and
dollar amount to be exchanged.
- Provide both account numbers.
- The Fund may ask for identification, and all telephone transactions are
recorded.
HOW TO REDEEM SHARES
All orders to redeem shares received in good order by the distributor,
transfer agent or other agent before the close of trading on the NYSE will be
executed at that day's share price. Orders received in good order after the
close of trading will be executed at the next business day's price. All
redemption orders must include the required documentation and signatures. The
Series may postpone payment of redemption proceeds for up to seven days, or
suspend redemptions to the extent permitted by law. If you recently purchased
your shares by check, your redemption proceeds will not be sent to you for 15
days.
BY MAIL
- Send a letter of instruction to Exeter Fund, Inc., at the address on
the opposite page signed by each registered account owner.
- State the name of the Series, and the number of shares or dollar
amount to be sold.
- Provide the account number.
- Signature guarantees may be required.
- Additional documentation may be required (call the Fund for details).
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INVESTMENT AND ACCOUNT INFORMATION
ACCOUNTS WITH LOW BALANCES
If your account falls below $1,000 due to the redemption of shares, the Fund
may ask you to bring your account up to the minimum requirement. If your
account is still below $1,000 after 60 days, the Fund may close your account
and send you the redemption proceeds.
IN-KIND PURCHASES AND REDEMPTIONS
Securities you own may be used to purchase shares of the Series. The Advisor
will determine if acquiring the securities is consistent with the Series' goals
and policies. If accepted, the securities will be valued the same way the Series
values securities it already owns.
The Series may make payment for shares in part by giving you portfolio
securities. As a redeeming shareholder, you will pay transaction costs to
dispose of these securities.
SIGNATURE GUARANTEES
A signature guarantee may be required for any written request to sell shares,
or to change the account registration.
The transfer agent will accept signature guarantees from:
- A member of the STAMP program or the NYSE's Medallion Signature Program.
- A broker or securities dealer.
- A federal savings, cooperative or other type of bank.
- A savings and loan or other thrift institution.
- A credit union.
- A securities exchange or clearing agency.
A NOTARY PUBLIC CANNOT PROVIDE A SIGNATURE GUARANTEE.
VALUATION OF SHARES
The Series offers its shares at the net asset value (NAV) per share of the
Series. The Series calculates its NAV once daily as of the close of regular
trading on the NYSE (generally at 4:00 p.m., New York time) on each day the
exchange is open. If the exchange closes early, the Series will accelerate the
calculation of NAV and transaction deadlines to that time.
The Series values the securities in its portfolio on the basis of market
quotations and valuations provided by independent pricing services. If
quotations are not readily available, the Series values its assets by a
method that the directors believe accurately reflects fair value. A Series
that uses fair value to price securities may value those securities higher or
lower than another Series that uses market quotations to price the same
securities.
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DIVIDENDS, DISTRIBUTIONS, AND TAXES
DIVIDENDS AND DISTRIBUTIONS
The Series generally:
- Pays dividends once a year, in December.
- Makes capital gains distributions, if any, once a year, typically in
December.
The Series may pay additional distributions and dividends at other times if
necessary for the Series to avoid a federal tax.
Capital gain distributions and dividends are reinvested in additional shares of
the same class that you hold. Alternatively, you can instruct the transfer agent
in writing or by telephone to have your capital gains and/or dividends paid in
cash. You can change your choice at any time to be effective as of the next
distribution or dividend, except that any change given to the transfer agent
after the record date will not be effective until the next distribution or
dividend is made. No interest will accrue on amounts represented by uncashed
distribution or redemption checks.
TAXES
TRANSACTION FEDERAL TAX STATUS
Redemption or exchange of shares Usually taxable as capital gain or loss;
long-term only if shares owned more
than one year
Long-term capital gain distributions Taxable as long-term capital gain
Short-term capital gain distributions Taxable as ordinary income
Dividends Taxable as ordinary income
Tax Exempt Income Free of federal income tax
If you are a taxable investor, you may want to avoid buying shares when the
Series is about to declare a capital gain distribution or a dividend, because
it will be taxable to you even though it may actually be a return of a
portion of your investment.
After the end of each year, the Series will provide you with information
about the distributions and dividends that you received and any redemptions
of shares during the previous year. In calculating your gain or loss on any
sale of shares, note that your tax basis in your shares is increased by the
amounts of dividends and distributions that you have reinvested in a Series.
Dividends and distributions are taxable as described above whether received
in cash or reinvested.
If you do not provide the Series with your correct taxpayer identification
number and any required certifications, you may be subject to back-up
withholding of 31% of your distributions, dividends and redemption proceeds.
Because each shareholder's circumstances are different and special tax rules
may apply, you should consult with your tax adviser about your investment in
the Series and your receipt of dividends, distributions or redemption
proceeds.
PAGE 11
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EXETER FUND, INC.
PUREMARK-SM- SERIES
CLASS A SHARES
SHAREHOLDER REPORTS AND THE STATEMENT OF ADDITIONAL INFORMATION (SAI)
Annual and semiannual reports to shareholders provide additional information
about the Series' investments. These reports discuss the market conditions
and investment strategies that significantly affected the Series' performance
during its last fiscal year. The SAI provides more detailed information about
the Series. It is incorporated by reference into this prospectus.
HOW TO OBTAIN THESE REPORTS AND ADDITIONAL INFORMATION
- You may obtain shareholder reports, when available, and the SAI or
other information about the Series without charge, by calling
1-800-466-3863 or sending written requests to Exeter Fund, Inc., P.O.
Box 41118, Rochester, New York 14604.
- You may review shareholder reports, the prospectus and SAI at the
Securities and Exchange Commission's Public Reference Room in Washington,
D.C. You can get copies of these materials for a fee by writing to the
Public Reference Section of the Commission, Washington, D.C. 20549-6009.
Information about the public reference room may be obtained by calling
1-800-SEC-0330. You can get the same reports and information free from
the SEC's Internet web site (http://www.sec.gov).
If someone makes a statement about the Series that is not in this prospectus,
you should not rely upon that information. Neither the Series nor its
distributor is offering to sell shares of the Series to any person to whom the
Series may not lawfully sell its shares.
Investment Company Act file no. 811-04087
PAGE 12
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EXETER FUND, INC.
STATEMENT OF ADDITIONAL INFORMATION DATED March 1, 1999
AS SUPPLEMENTED ON SEPTEMBER 1, 1999
This Statement of Additional Information is not a Prospectus, and it should
be read in conjunction with the Prospectus for each of the following series
of Exeter Fund, Inc. (the "Fund"): Blended Asset Series I, Blended Asset
Series II, Flexible Yield Series I, Flexible Yield Series II, Flexible Yield
Series III, Tax Managed Series, Defensive Series, Maximum Horizon Series, and
PureMark-SM- Series (each a "series"), copies of which may be obtained from
Exeter Asset Management, 1100 Chase Square, Rochester, NY 14604. This SAI
relates to the Class A, B, C, D and E Shares of each series.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
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<S> <C>
Investment Goals.................................................B-2
Investment Policies and Risks....................................B-2
Investment Restrictions..........................................B-23
Portfolio Turnover...............................................B-26
The Fund.........................................................B-26
Management.......................................................B-28
The Advisor......................................................B-34
Distribution of Fund Shares......................................B-36
Custodian, Independent Accountants and Counsel...................B-38
Purchases and Redemptions........................................B-38
Portfolio Transactions and Brokerage.............................B-38
Net Asset Value..................................................B-40
Federal Tax Treatment of Dividends and Distributions.............B-40
Performance Information..........................................B-44
Financial Statements.............................................B-45
Appendix - Description of Bond Ratings...........................B-46
</TABLE>
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INVESTMENT GOALS
Each of the series' investment goals as well as its principal investment
policies and strategies with respect to the composition of their respective
portfolios are described in the prospectus. The following sections provide more
information about those principal policies and strategies as well as information
about other policies and strategies. Each series' investment goal is not
fundamental and may be changed by the Board of Directors without shareholder
approval. If there is a change in a series' investment objective, shareholders
will be notified thirty (30) days prior to any such change and will be advised
to consider whether the fund remains an appropriate investment in light of their
then current financial position and needs. Each of the series is a diversified
mutual fund.
INVESTMENT POLICIES AND RISKS
EQUITY INVESTMENTS
COMMON STOCKS. Each series may purchase common stocks. Common stocks are shares
of a corporation or other entity that entitle the holder to a pro rata share of
the profits of the corporation, if any, without preference over any other
shareholder or class of shareholders, including holders of the entity's
preferred stock and other senior equity. Common stock usually carries with it
the right to vote and frequently an exclusive right to do so.
PREFERRED STOCKS. Each series may invest in preferred stocks. Preferred stocks
may pay a dividend at a fixed rate, and may entitle the holder to acquire the
issuer's stock by exchange or purchase for a predetermined rate.
CONVERTIBLE SECURITIES. Each series may invest in securities that are
convertible at either a stated price or a stated rate into underlying shares of
common stock, thus enabling the investor to benefit from increases in the market
price of the common stock. Convertible securities provide higher yields than the
underlying equity, but generally offer lower yields than non-convertible
securities of similar quality. Like bonds, the value of convertible securities
fluctuates in relation to changes in interest rates and, in addition, also
fluctuates in relation to the underlying common stock. The principal factor in
selecting convertible bonds is the potential to benefit from movement in the
stock price. There is no minimum rating standard for the debt aspects of such
securities. Convertible bonds purchased by a series may be subject to the risk
of being called by the issuer.
WARRANTS. Each series may purchase warrants. Warrants acquired by a series
entitle it to buy common stock from the issuer at a specified price and time.
Warrants may be considered more speculative than certain other types of
investments because they (1) do not carry rights to dividends or voting rights
with respect to the securities which the warrant entitles the holder to
purchase, and (2) do not represent any rights in the assets of the issuer.
Warrants purchased by the Fund may or may not be listed on a national securities
exchange. As a fundamental investment policy, none of the series (except for the
Flexible Yield Series I, Flexible Yield Series II, and the Flexible Yield Series
III) may invest more than 5% of the value of its total net assets in warrants.
Included within that amount, but not to exceed 2% of
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the value of the series' net assets, may be warrants which are not listed on the
New York or American Stock Exchange.
REITS. Each series may invest in shares of real estate investment trusts
("REITs"), which are pooled investment vehicles that invest in real estate or
real estate loans or interests. Investing in REITs involves risks similar to
those associated with investing in equity securities of small capitalization
companies. REITs are dependent upon management skills, are not diversified, and
are subject to risks of project financing, default by borrowers,
self-liquidation, and the possibility of failing to qualify for the exemption
from taxation on distributed amounts under the Internal Revenue Code of 1986, as
amended (the "Code").
TRUST CERTIFICATES, PARTNERSHIP INTERESTS AND EQUITY PARTICIPATIONS. Each series
may invest in equity securities that are interests in non-corporate entities.
These securities, which include trust certificates, partnership interests and
equity participations, have different liability and tax characteristics than
equity securities issued by a corporation, and thus may present additional risks
to the series. However, the investment characteristics of these securities are
similar to those of traditional corporate equity securities.
FIXED INCOME INVESTMENTS
CORPORATE DEBT OBLIGATIONS. Each series may invest in corporate debt obligations
issued by financial institutions and corporations. Corporate debt obligations
are subject to the risk of an issuer's inability to meet principal and interest
payments on the obligations and may also be subject to price volatility due to
such factors as market interest rates, market perception of the creditworthiness
of the issuer and general market liquidity.
U.S. GOVERNMENT SECURITIES. Each series may invest in debt obligations of
varying maturities issued or guaranteed by the U.S. Government, its agencies or
instrumentalities. Direct obligations of the U.S. Treasury which are backed by
the full faith and credit of the U.S. Government, include a variety of Treasury
securities that differ only in their interest rates, maturities and dates of
issuance. U.S. Government agencies or instrumentalities which issue or guarantee
securities include, but are not limited to, the Federal Housing Administration,
Federal National Mortgage Association, Farmers Home Administration,
Export-Import Bank of the United States, Small Business Administration,
Governmental National Mortgage Association, General Services Administration,
Central Bank for Cooperatives, Federal Home Loan Banks, Federal Home Loan
Mortgage Corporation, Federal Intermediate Credit Banks, Federal Land Banks,
Maritime Administration, the Tennessee Valley Authority, District of Columbia
Armory Board and the Student Loan Marketing Association.
Obligations of U.S. Government agencies and instrumentalities may or may not be
supported by the full faith and credit of the United States. Some are backed by
the right of the issuer to borrow from the U.S. Treasury; others by
discretionary authority of the U.S. Government to purchase the agencies'
obligations; while still others, such as the Student Loan Marketing Association,
are supported only by the credit of the instrumentality. In the case of
securities not backed by the full faith and credit of the United States, the
investor must look principally to the agency or instrumentality
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issuing or guaranteeing the obligation for ultimate repayment, and may not be
able to assert a claim against the United States itself in the event the agency
or instrumentality does not meet its commitment.
A series will invest in securities of such instrumentality only when the Fund's
investment advisor, Exeter Asset Management (the "Advisor"), is satisfied that
the credit risk with respect to any instrumentality is minimal.
MORTGAGE-BACKED SECURITIES. Each series may invest in mortgage-backed securities
which represent an interest in a pool of mortgage loans. These securities are
issued or guaranteed by U.S. Government agencies or instrumentalities such as
the Government National Mortgage Association ("GNMA"), Fannie Mae, and the
Federal Home Loan Mortgage Corporation ("FHLMC"). Obligations of GNMA are backed
by the full faith and credit of the United States Government. Obligations of
Fannie Mae and FHLMC are not backed by the full faith and credit of the United
States Government but are considered to be of high quality since they are
considered to be instrumentalities of the United States. The market value and
interest yield of these mortgage-backed securities can vary due to market
interest rate fluctuations and early prepayments of underlying mortgages. These
securities represent ownership in a pool of federally insured mortgage loans
with a maximum maturity of 30 years. However, due to scheduled and unscheduled
principal payments on the underlying loans, these securities have a shorter
average maturity and, therefore, less principal volatility than a comparable
30-year bond. Since prepayment rates vary widely, it is not possible to
accurately predict the average maturity of a particular mortgage-backed
security. The scheduled monthly interest and principal payments relating to
mortgages in the pool will be "passed through" to investors. Government
mortgage-backed securities differ from conventional bonds in that principal is
paid back to the certificate holders over the life of the loan rather than at
maturity. As a result, there will be monthly scheduled payments of principal and
interest. In addition, there may be unscheduled principal payments representing
prepayments on the underlying mortgages. Although these securities may offer
yields higher than those available from other types of U.S. Government
securities, mortgage-backed securities may be less effective than other types of
securities as a means of "locking in" attractive long-term rates because of the
prepayment feature. For instance, when interest rates decline, the value of
these securities likely will not rise as much as comparable debt securities due
to the prepayment feature. In addition, these prepayments can cause the price of
a mortgage-backed security originally purchased at a premium to decline in price
to its par value, which may result in a loss.
Each series may also invest in collateralized mortgage obligations ("CMOs") and
real estate mortgage investment conduits ("REMICs"), which are rated in one of
the two top categories by Standard & Poor's Corporation ("S&P") or Moody's
Investors Service ("Moody's"). CMOs are securities collateralized by mortgages,
mortgage pass-throughs, mortgage pay-through bonds (bonds representing an
interest in a pool of mortgages where the cash flow generated from the mortgage
collateral pool is dedicated to bond repayment), and mortgage-backed bonds
(general obligations of the issuers payable out of the issuer's general funds
and additionally secured by a first lien on a pool of single family detached
properties). Many CMOs are issued with a number of classes or series which have
different maturities and are retired in sequence.
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Investors purchasing such CMOs in the shortest maturities receive or are
credited with their pro rata portion of the scheduled payments of interest and
principal on the underlying mortgages plus all unscheduled prepayments of
principal up to a predetermined portion of the total CMO obligation. Until that
portion of such CMO obligation is repaid, investors in the longer maturities
receive interest only. Accordingly, the CMOs in the longer maturity series are
less likely than other mortgage pass-throughs to be prepaid prior to their
stated maturity. Although some of the mortgages underlying CMOs may be supported
by various types of insurance, and some CMOs may be backed by GNMA certificates
of other mortgage pass-throughs issued or guaranteed by U.S. government agencies
or instrumentalities, the CMOs themselves are not generally guaranteed.
REMICs, which were authorized under the Tax Reform Act of 1986, are private
entities formed for the purpose of holding a fixed pool of mortgages secured by
an interest in real property. REMICs are similar to CMOs in that they issue
multiple classes of securities.
ASSET-BACKED SECURITIES. Each series may invest in asset-backed securities.
These securities, issued by trusts and special purpose corporations, are backed
by a pool of assets, such as credit card and automobile loan receivables,
representing the obligations of a number of different parties.
Asset-backed securities present certain risks. For instance, in the case of
credit card receivables, these securities may not have the benefit of any
security interest in the related collateral. Credit card receivables are
generally unsecured and the debtors are entitled to the protection of a number
of state and federal consumer credit laws, many of which give such debtors the
right to set off certain amounts owed on the credit cards, thereby reducing the
balance due. Most issuers of automobile receivables permit the servicers to
retain possession of the underlying obligations. If the servicer were to sell
these obligations to another party, there is a risk that the purchaser would
acquire an interest superior to that of the holders of the related automobile
receivables. In addition, because of the large number of vehicles involved in a
typical issuance and technical requirements under state laws, the trustee for
the holders of the automobile receivables may not have a proper security
interest in all of the obligations backing such receivables. Therefore, there is
the possibility that recoveries on repossessed collateral may not, in some
cases, be available to support payments on these securities.
Asset-backed securities are often backed by a pool of assets representing the
obligations of a number of different parties. To lessen the effect of failures
by obligors to make payments on underlying assets, the securities may contain
elements of credit support which fall into two categories: (i) liquidity
protection and (ii) protection against losses resulting from ultimate default by
an obligor on the underlying assets. Liquidity protection refers to the
provision of advances, generally by the entity administering the pool of assets,
to ensure that the receipt of payments on the underlying pool occurs in a timely
fashion. Protection against losses resulting from ultimate default ensures
payment through insurance policies or letters of credit obtained by the issuer
or sponsor from third parties. The degree of credit support provided for each
issue is generally based on historical information respecting the level of
credit risk associated with the underlying assets.
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Delinquency or loss in excess of that anticipated or failure of the credit
support could adversely affect the return on an instrument in such a security.
The estimated life of an asset-backed security varies with the prepayment
experience with respect to the underlying debt instruments. The rate of such
prepayments, and hence the life of an asset-backed security, will be primarily a
function of current market interest rates, although other economic and
demographic factors may be involved. For example, falling interest rates
generally result in an increase in the rate of prepayments of mortgage loans
while rising interest rates generally decrease the rate of prepayments.
Consequently, asset-backed securities are subject to call risk and extension
risk (described below).
BELOW INVESTMENT GRADE DEBT SECURITIES. Each series may invest up to 20% of its
assets in corporate debt securities rated below investment grade. High risk,
high yield securities rated below BBB or lower by S&P or Baa or lower by Moody's
are "below investment grade" and are considered to have speculative
characteristics and involve greater risk of default or price changes due to
changes in the issuer's credit-worthiness. Market prices of these securities may
fluctuate more than high-rated securities and they are difficult to price at
times because they are more thinly traded and less liquid securities. Market
prices may decline significantly in periods of general economic difficulty which
may follow periods of rising interest rates. Securities in the lowest rating
category may be in default. For these reasons, it is the series' policy not to
rely primarily on ratings issued by established credit rating agencies, but to
utilize such ratings in conjunction with the Advisor's own independent and
ongoing review of credit quality. In the event a security is downgraded below
these ratings after purchase, the Advisor will review and take appropriate
action with regard to the security. Each series will also seek to minimize risk
by diversifying its holdings.
YANKEE BONDS. Each series may invest in U.S. dollar-denominated bonds sold in
the United States by non-U.S. issuers ("Yankee bonds"). As compared with bonds
issued in the United States, such bond issues normally carry a higher interest
rate but are less actively traded.
OBLIGATIONS OF SUPRANATIONAL AGENCIES. Currently, the Flexible Yield Series I,
Flexible Yield Series II and the Flexible Yield Series III may purchase
securities issued or guaranteed by supranational agencies including, but not
limited to, the following: Asian Development Bank, Inter-American Development
Bank, International Bank for Reconstruction and Development (World Bank),
African Development Bank, European Coal and Steel Community, European Economic
Community, European Investment Bank and the Nordic Investment Bank. For
concentration purposes, supranational entities are considered an industry.
Investment in these entities is subject to the series' other restrictions on
investments in foreign securities, described below.
ZERO-COUPON BONDS. Some of the securities in which the series invest may include
so-called "zero-coupon" bonds. Zero-coupon bonds are issued at a significant
discount from face value and generally pay interest only at maturity rather than
at intervals during the life of the security. Each series is required to accrue
and distribute income from zero-coupon bonds on a current basis, even though it
does not receive that income currently in cash. Thus, the series may have to
sell investments to obtain cash needed to make
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income distributions. The discount in the absence of financial difficulties of
the issuer decreases as the final maturity of the security approaches.
Zero-coupon bonds can be sold prior to their maturity date in the secondary
market at the then prevailing market value, which depends primarily on the time
remaining to maturity, prevailing level of interest rates and the perceived
credit quality of the issues. The market prices of zero-coupon securities are
subject to greater fluctuations in response to changes in market interest rates
than bonds which pay interest currently.
VARIABLE AND FLOATING RATE INSTRUMENTS. Certain of the obligations purchased by
a series may carry variable or floating rates of interest, may involve a
conditional or unconditional demand feature and may include variable amount
master demand notes. Such instruments bear interest at rates which are not
fixed, but which vary with changes in specified market rates or indices, such as
a Federal Reserve composite index. The interest rate on these securities may be
reset daily, weekly, quarterly, or at some other interval, and it may have a
floor or ceiling rate. There is a risk that the current interest rate on such
obligations may not accurately reflect existing market interest rates.
SHORT-TERM INVESTMENTS. For temporary defensive purposes during periods when the
Advisor determines that market conditions warrant, each series may depart from
its investment goals and invest up to 100% of its assets in all types of money
market instruments (including securities guaranteed by the U.S. Government, its
agencies or instrumentalities, certificates of deposit, time deposits and
bankers' acceptances issued by banks or savings and loan institutions deemed
creditworthy by the Advisor, commercial paper rated A-1 by S&P or Prime-1 by
Moody's, repurchase agreements involving such securities and shares of other
investment companies as permitted by applicable law) and may hold a portion of
its assets in cash. For a description of the above ratings, see the Appendix.
RISKS OF FIXED INCOME SECURITIES. Investments in fixed income securities may
subject the series to risks, including the following:
INTEREST RATE RISK. When interest rates decline, the market value of fixed
income securities tends to increase. Conversely, when interest rates
increase, the market value of fixed income securities tends to decline. The
volatility of a security's market value will differ depending upon the
security's duration, the issuer and the type of instrument.
DEFAULT RISK/CREDIT RISK. Investments in fixed income securities are
subject to the risk that the issuer of the security could default on its
obligations, causing a series to sustain losses on such investments. A
default could impact both interest and principal payments.
CALL RISK AND EXTENSION RISK. Fixed income securities may be subject to
both call risk and extension risk. Call risk exists when the issuer may
exercise its right to pay principal on an obligation earlier than
scheduled, which would cause cash flows to be returned earlier than
expected. This typically results when interest rates have declined and a
series will suffer from having to reinvest in lower yielding securities.
Extension risk exists when the issuer may exercise its right to pay
principal on an obligation later than scheduled, which
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would cause cash flows to be returned later than expected. This typically
results when interest rates have increased, and a series will suffer from
the inability to invest in higher yield securities.
HEDGING (DERIVATIVE TRANSACTIONS)
ALL OF THE SERIES' POLICIES (EXCEPT FOR THOSE OF THE PUREMARK-SM- SERIES)
REGARDING OPTIONS DISCUSSED BELOW ARE FUNDAMENTAL, AND MAY ONLY BE CHANGED BY
A SHAREHOLDER VOTE.
IN GENERAL. Each series has reserved the right, subject to authorization by the
Board of Directors prior to implementation, to engage in certain strategies in
an attempt to hedge the series' portfolios, that is, to reduce the overall level
of risk that normally would be expected to be associated with their investments.
Each series may write covered call options on common stocks; may purchase and
sell (on a secured basis) put options; and may engage in closing transactions
with respect to put and call options. Each series also may purchase forward
foreign currency exchange contracts to hedge currency exchange rate risk. In
addition, each series is authorized to purchase and sell stock index futures
contracts and options on stock index futures contracts. Each series is also
authorized to conduct spot (i.e., cash basis) currency transactions or to use
currency futures contracts and options on futures contracts and foreign
currencies in order to protect against uncertainty in the future levels of
foreign currency exchange rates. These strategies are primarily used for hedging
purposes; nevertheless, there are risks associated with these strategies as
described below.
OPTIONS ON SECURITIES. As a means of protecting its assets against market
declines, and in an attempt to earn additional income, each series may write
covered call option contracts on its securities and may purchase call options
for the purpose of terminating its outstanding obligations with respect to
securities upon which covered call option contracts have been written.
When a series writes a call option on securities which it owns, it gives the
purchaser of the option the right to buy the securities at an exercise price
specified in the option at any time prior to the expiration of the option. If
any option is exercised, a series will realize the gain or loss from the sale of
the underlying security and the proceeds of the sale will be increased by the
net premium originally received on the sale of the option. By writing a covered
call option, a series may forego, in exchange for the net premium, the
opportunity to profit from an increase in the price of the underlying security
above the option's exercise price. A series will have kept the risk of loss if
the price of the security declines, but will have reduced the effect of that
risk to the extent of the premium it received when the option was written.
A series will write only covered call options which are traded on national
securities exchanges. Currently, call options on stocks may be traded on the
Chicago Board Options Exchange and the New York, American, Pacific and
Philadelphia Stock Exchanges. Call options are issued by the Options Clearing
Corporation ("OCC"), which also serves as the clearing house for transactions
with respect to standardized or listed options. The price of a call option is
paid to the writer without refund on expiration or exercise, and no portion of
the price is retained by OCC or the exchanges listed above. Writers and
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purchasers of options pay the transaction costs, which may include commissions
charged or incurred in connection with such option transactions.
A series may write only covered call options. A call option is considered to be
covered if the option writer owns the security underlying the call or has an
absolute and immediate right to acquire that security without payment of
additional cash consideration (or for additional cash consideration held in a
separate account) upon conversion or exchange of other securities. A call option
is also considered to be covered if the writer holds on a unit-for-unit basis a
call on the same security as the call written, has the same expiration date and
the exercise price of the call purchased is equal to or less than the exercise
price of the call written or greater than the exercise price of the call written
if the difference is maintained in cash or other liquid securities in a separate
account, and marked-to-market daily. A series will not sell (uncover) the
securities against which options have been written until after the option period
has expired, the option has been exercised or a closing purchase has been
executed.
Options written by a series will have exercise prices which may be below
("in-the-money"), equal to ("at-the-money") or above ("out-of-the-money") the
market price of the underlying security at the time the options are written.
However, a series generally will not write so-called "deep-in-the-money"
options.
The market value of a call option generally reflects the market price of the
underlying security. Other principal factors affecting market value include
supply and demand, dividend yield and interest rates, the price volatility of
the underlying security and the time remaining until the expiration date.
If a call option on a security expires unexercised, a series will realize a gain
in the amount of the premium on the option, less all commissions paid. Such a
gain, however, may be offset by a decline in the value of the underlying
security during the option period. If a call option is exercised, a series will
realize a gain or loss from the sale of the underlying security equal to the
difference between the cost of the underlying security and the proceeds of the
sale of the security (exercise price minus commission) plus the amount of the
premium on the option, less all commissions paid.
Call options may also be purchased by a series, but only to terminate (entirely
or in part) a series' obligation as a writer of a call option. This is
accomplished by making a closing purchase transaction, that is, the purchase of
a call option on the same security with the same exercise price and expiration
date as specified in the call option which had been written previously. A
closing purchase transaction with respect to calls traded on a national
securities exchange has the effect of extinguishing the obligation of the writer
of a call option. A series may enter into a closing purchase transaction, for
example, to realize a profit on an option it had previously written, to enable
it to sell the security which underlies the option, to free itself to sell
another option or to prevent its portfolio securities from being purchased
pursuant to the exercise of a call. A series may also permit the call option to
be exercised. A closing transaction cannot be effected with respect to an
optioned security once a series has received a notice that the option is to be
exercised.
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The cost to a series of such a closing transaction may be greater than the net
premium received by a series upon writing the original call option. A profit or
loss from a closing purchase transaction will be realized depending on whether
the amount paid to purchase a call to close a position is less or more than the
amount received from writing the call. Any profit realized by a series from the
execution of a closing transaction may be partly or completely offset by a
reduction in the market price of the underlying security.
A series may also write secured put options and enter into closing purchase
transactions with respect to such options. A series may write secured put
options on national securities exchanges to obtain, through the receipt of
premiums, a greater return than would be realized on the underlying securities
alone. A put option gives the purchaser of the option the right to sell, and the
writer has the obligation to buy, the underlying security at the stated exercise
price during the option period. The secured put writer retains the risk of loss
should the market value of the underlying security decline below the exercise
price of the option. During the option period, the writer of a put option may be
required at any time to make payment of the exercise price against delivery of
the underlying security. The operation of put options in other respects is
substantially identical to that of call options. The Fund will establish a
separate account consisting of liquid assets equal to the amount of the series
assets that could be required to consummate the put options. For purposes of
determining the adequacy of the securities in the account, the deposited assets
will be valued at fair market value. If the value of such assets declines,
additional cash or assets will be placed in the account daily so that the value
of the account will equal the amount of such commitments by the series.
A put option is secured if a series maintains in a separate account liquid
assets in an amount not less than the exercise price of the option at all times
during the option period. A series may write secured put options when the
Advisor wishes to purchase the underlying security for a series' portfolio at a
price lower than the current market price of the security. In such event a
series would write a secured put option at an exercise price which, reduced by
the premium received on the option, reflects the lower price it is willing to
pay. The potential gain on a secured put option is limited to the income earned
on the amount held in liquid assets plus the premium received on the option
(less the commissions paid on the transaction) while the potential loss equals
the difference between the exercise price of the option and the current market
price of the underlying securities when the put is exercised, offset by the
premium received (less the commissions paid on the transaction) and income
earned on the amount held in liquid assets.
A series may purchase put options on national securities exchanges in an attempt
to hedge against fluctuations in the value of its portfolio securities and to
protect against declines in the value of individual securities. Purchasing a put
option allows the purchaser to sell the particular security covered by the
option at a certain price (the "exercise price") at any time up to a specified
future date (the "expiration date").
Purchase of a put option creates a "hedge" against a decline in the value of the
underlying security by creating the right to sell the security at a specified
price. Purchase of a put option requires payment of a premium to the seller of
that option. Payment of this premium necessarily reduces the
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return available on the individual security should that security continue to
appreciate in value. In return for the premium paid, a series protects itself
against substantial losses should the security suffer a sharp decline in value.
In contrast to covered call option writing, where one obtains greater current
income at the risk of foregoing potential future gains, one purchasing put
options is in effect foregoing current income in return for reducing the risk of
potential future losses.
A series will purchase put options as a means of "locking in" profits on
securities held in the portfolio. Should a security increase in value from the
time it is initially purchased, a series may seek to lock in a certain profit
level by purchasing a put option. Should the security thereafter continue to
appreciate in value the put option will expire unexercised and the total return
on the security, if it continues to be held by a series, will be reduced by the
amount of premium paid for the put option. At the same time, a series will
continue to own the security. Should the security decline in value below the
exercise price of the put option, however, a series may elect to exercise the
option and "put" or sell the security to the party that sold the put option to
that series, at the exercise price. In this case a series would have a higher
return on the security than would have been possible if a put option had not
been purchased.
RISKS FACTORS AND CERTAIN OTHER FACTORS RELATING TO OPTIONS. Positions in
options on securities may be closed only by a closing transaction, which may be
made only on an exchange which provides a liquid secondary market for such
options. Although a series will write options only when the Advisor believes a
liquid secondary market will exist on an exchange for options of the same
series, there can be no assurance that a liquid secondary market will exist for
any particular security option. If no liquid secondary market exists respecting
an option position held, a series may not be able to close an option position,
which will prevent that series from selling any security position underlying an
option until the option expires and may have an adverse effect on its ability
effectively to hedge its security positions. A secured put option writer who is
unable to effect a closing purchase transaction would continue to bear the risk
of decline in the market price of the underlying security until the option
expires or is exercised. In addition, a secured put writer would be unable to
use the amount held in liquid assets as security for the put option for other
investment purposes until the exercise or expiration of the option.
Possible reasons for the absence of a liquid secondary market on an exchange
include the following: (i) insufficient trading; (ii) restrictions that may be
imposed by an exchange on opening transactions or closing transactions or both;
(iii) trading halts, suspensions or other restrictions that may be imposed with
respect to particular classes or series of contracts, or underlying securities;
(iv) unusual or unforeseen circumstances that may interrupt normal operations on
an exchange; (v) the facilities of an exchange or a clearing corporation may not
be adequate to handle unusual trading volume; or (vi) one or more exchanges
could, for economic or other reasons, decide or be compelled at some future date
to discontinue the trading of contracts (or particular class or series of
contracts), in which event the secondary market on that exchange would cease to
exist, although outstanding contracts on the exchange that had been issued by a
clearing corporation as a result of trades on that exchange would continue to be
exercisable in
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accordance with their terms. There is no assurance that higher than anticipated
trading activity or other unforeseen events might not, at times, render certain
of the facilities of any of the clearing corporations inadequate, and thereby
result in the institution by an exchange of special procedures which may
interfere with timely execution of customers' orders.
Each of the exchanges on which options on securities are traded has established
limitations on the number of options which may be written by any one investor or
group of investors. These limitations apply regardless of whether the options
are written in different accounts or through different brokers. It is possible
that a series and certain other accounts managed by the Advisor, may constitute
such a group. If so, the options positions of the series may be aggregated with
those of other clients of the Advisor.
If a series writes an over-the-counter ("OTC") option, it will enter into an
arrangement with a primary U.S. government securities dealer, which would
establish a formula price at which the series would have the absolute right to
repurchase that OTC option. This formula price would generally be based on a
multiple of the premium received for the option, plus the amount by which the
option is exercisable below the marked price of the underlying security
("in-the-money"). For an OTC option a series writes, it will treat as illiquid
(for purposes of the 10% net asset limitation on illiquid securities) an amount
of assets used to cover written OTC options, equal to the formula price for the
repurchase of the OTC option less the amount by which the OTC option is
"in-the-money". A series will also treat as illiquid any OTC option held by it.
The Securities and Exchange Commission ("SEC") is evaluating the general issue
of whether or not the OTC options should be considered to be liquid securities,
and the procedure described above could be affected by the outcome of that
evaluation.
Although the OCC has stated that it believes (based on forecasts provided by the
exchanges on which options are traded), that its facilities are adequate to
handle the volume of reasonably anticipated options transactions, and although
each exchange has advised the OCC that it believes that its facilities will also
be adequate to handle reasonably anticipated volume, there can be no assurance
that higher than anticipated trading activity or order flow or other unforeseen
events might not at times render certain of these facilities inadequate and
thereby result in the institution of special trading procedures or restrictions.
The series will pay brokerage and other transaction costs to write and purchase
options on securities, including any closing transactions which the series may
execute. Therefore, frequent writing and/or purchasing of options may increase
the transaction costs borne by the series.
STOCK INDEX FUTURES CONTRACTS AND OPTIONS ON STOCK INDEX FUTURES CONTRACTS. Each
series, except for Flexible Yield Series I, Flexible Yield Series II and
Flexible Yield Series III of the Fund, may enter into stock index futures
contracts to provide: (1) a hedge for a portion of the series' portfolio; (2) a
cash management tool; (3) as an efficient way to implement either an increase or
decrease in portfolio market exposure in response to changing market conditions.
The series may also use stock index futures as a substitute for comparable
market position in the underlying securities. Although techniques other than the
sale and purchase of stock index futures
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contracts could be used to adjust the exposure or hedge the series' portfolio,
the series may be able to do so more efficiently and at a lower cost through the
use of stock index futures contracts.
A stock index futures contract is a contract to buy or sell units of a stock
index at a specified future date at a price agreed upon when the contract is
made. Entering into a contract to buy units of a stock index is commonly
referred to as buying or purchasing a contract or holding a long position in the
index. Entering into a contract to sell units of a stock index is commonly
referred to as selling a contract or holding a short position. A stock index
future obligates the seller to deliver (and the purchaser to take) an amount of
cash equal to a specific dollar amount times the difference between the value of
a specific stock index at the close of the last trading day of the contract and
the price at which the agreement is made. No physical delivery of the underlying
stocks in the index is made. The series intend to purchase and sell futures
contracts on the stock index for which they can obtain the best price with
consideration also given to liquidity.
The series will not enter into a stock index futures contract or option thereon
if, as a result thereof, the sum of the amount of initial margin deposits on any
such futures (plus deposits on any other futures contracts and premiums paid in
connection with any options or futures contracts) that do not constitute "bona
fide hedging" under Commodity Futures Trading Commission ("CFTC") rules would
exceed 5% of the liquidation value of the series' total assets after taking into
account unrealized profits and losses on such contracts. In addition, the value
of all futures contracts sold will not exceed the total market value of the
series' portfolio. The series will comply with guidelines established by the
Securities and Exchange Commission with respect to the covering of obligations
under future contracts and will set aside liquid assets in a separate account in
the amount prescribed.
Unlike the purchase or sale of an equity security, no price is paid or received
by the series upon the purchase or sale of a stock index futures contract. Upon
entering into a Futures Contract, the series would be required to deposit into a
separate account in the name of the futures broker an amount of cash or liquid
securities known as "initial margin." This amount is required by the rules of
the exchanges and is subject to change. The nature of initial margin in futures
transactions is different from that of margin in security transactions in that
futures margin does not involve the borrowing of funds by the series to finance
the transactions. Rather, initial margin is in the nature of a performance bond
or good faith deposit on the contract that is returned to the series upon
termination of the futures contract, assuming all contractual obligations have
been satisfied.
Subsequent payments, called "variation margin", to and from the futures broker,
are made on a daily basis as the price of the underlying stock index fluctuates,
making the long and short positions in the futures contract more or less
valuable, a process known as "marking-to-market". For example, when the series
has purchased a stock index futures contract and the price of the underlying
stock index has risen, that futures position will have increased in value and
the series will receive from the broker a variation margin payment equal to that
increase in value. Conversely, when the series has purchased a stock index
futures contract and the price of the stock index has declined,
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the position would be less valuable and the series would be required to make a
variation payment to the broker.
The loss from investing in futures transactions is potentially unlimited. To
limit such risk, the series will not enter into stock index futures contracts
for speculation and will only enter into futures contracts which are traded on
established futures markets. The series may, however, purchase or sell stock
index futures contracts with respect to any stock index. Nevertheless, to hedge
the series' portfolio successfully, the Advisor must sell stock index futures
contracts with respect to indices whose movements will, in its judgment, have a
significant correlation with movements in the prices of the series' portfolio
securities.
Closing out an open stock index futures contract sale or purchase is effected by
entering into an offsetting stock index futures contract purchase or sale,
respectively, for the same aggregate amount of identical securities with the
same delivery date. If the offsetting purchase price is less than the original
sale price, the series realize a gain; if it is more, the series realize a loss.
Conversely, if the offsetting sale price is more than the original purchase
price, the series realize a gain; if it is less, the series realize a loss. The
series must also be able to enter into an offsetting transaction with respect to
a particular stock index futures contract at a particular time. If the series
are not able to enter into an offsetting transaction, the series will continue
to be required to maintain the margin deposits on the stock index futures
contract.
The series may elect to close out some or all of their futures positions at any
time prior to expiration. The purpose of making such a move would be either to
reduce equity exposure represented by long futures positions or increase equity
exposure represented by short futures positions. The series may close their
positions by taking opposite positions which would operate to terminate the
series' position in the stock index futures contracts. Final determinations of
variation margin would then be made, additional cash would be required to be
paid or released to the series, and the series would realize a loss or a gain.
Stock index futures contracts may be closed out only on the exchange or board of
trade where the contracts were initially traded. Although the series intend to
purchase or sell stock index futures contracts only on exchanges or boards of
trade where there appears to be an active market, there is no assurance that a
liquid market on an exchange or board of trade will exist for any particular
time. In such an event, it might not be possible to close a stock index futures
contract, and in the event of adverse price movements, the series would continue
to be required to make daily cash payments of variation margin. However, in the
event stock index futures contracts have been used to hedge portfolio
securities, the series would continue to hold securities subject to the hedge
until the stock index futures contracts could be terminated. In such
circumstances, an increase in the price of the securities, if any, might
partially or completely offset losses on the stock index futures contract.
However, as described below, there is no guarantee that the price of the
securities will, in fact, correlate with price movements in the futures contract
and thus provide an offset to losses on a stock index futures contract.
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There are several risks in connection with the use by the series of stock index
futures contracts as a hedging device. One risk arises because of the imperfect
correlation between movements in the prices of the futures contracts and
movements in the prices of securities which are the subject of the hedge. The
Advisor will, however, attempt to reduce this risk by entering into stock index
futures contracts on indices whose movements, in its judgment, will have a
significant correlation with movements in the prices of the series' portfolio
securities sought to be hedged.
Successful use of stock index futures contracts by the series for hedging
purposes is also subject to the Advisor's ability to correctly predict movements
in the direction of the market. It is possible that, when the series have sold
futures to hedge their portfolios against a decline in the market, the index or
indices on which the futures are written might advance and the value of
securities held in the series' portfolio might decline. If this were to occur,
the series would lose money on the futures and also would experience a decline
in value in its portfolio securities. However, while this might occur to a
certain degree, the Advisor believes that over time the value of the series'
portfolio will tend to move in the same direction as the securities underlying
the futures, which are intended to correlate to the price movements of the
portfolio securities sought to be hedged. It is also possible that if the series
were to hedge against the possibility of a decline in the market (adversely
affecting stocks held in their portfolios) and stock prices instead increased,
the series would lose part or all of the benefit of increased value of those
stocks that it had hedged, because it would have offsetting losses in their
futures positions. In addition, in such situations, if the series had
insufficient cash, they might have to sell securities to meet their daily
variation margin requirements. Such sales of securities might be, but would not
necessarily be, at increased prices (which would reflect the rising market).
Moreover, the series might have to sell securities at a time when it would be
disadvantageous to do so.
In addition to the possibility that there might be an imperfect correlation, or
no correlation at all, between price movements in the stock index futures
contracts and the portion of the portfolio to be hedged, the price movements in
the Futures Contracts might not correlate perfectly with price movements in the
underlying stock index due to certain market distortions. First, all
participants in the futures market are subject to margin deposit and maintenance
requirements. Rather than meeting additional margin deposit requirements,
investors might close stock index futures contracts through offsetting
transactions which could distort the normal relationship between the index and
futures markets. Second, the margin requirements in the futures market are less
onerous than margin requirements in the securities markets. Due to the
possibility of price distortion in the futures market and also because of the
imperfect correlation between price movements in the stock index and movements
in the prices of stock index futures contracts, even a correct forecast of
general market trends by the Advisor might not result in a successful hedging
transaction over a very short time period.
Options on futures give the purchaser the right, in return for a premium paid,
to assume a position in a futures contract (a long position if a call option and
a short position if a put option), rather than to purchase or sell the stock
index futures contract, at a specified exercise price at any time during the
period of the option. Upon exercise of the option, the delivery of the
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futures position by the writer of the option to the holder of the option will be
accompanied by delivery of the accumulated balance in the writer's futures
margin account which represents the amount by which the market price of the
stock index futures contract, at exercise, 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 futures
contract. Alternatively, settlement may be made totally in cash.
Each series may seek to close out an option position on an index by writing or
buying an offsetting option covering the same index or contract and having the
same exercise price and expiration date. The ability to establish and close out
positions on such options will be subject to the development and maintenance of
a liquid secondary market. It is not certain that this market will develop. See
"Risk Factors and Certain Other Factors Relating to Options" above for possible
reasons for the absence of a liquid secondary market on an exchange.
FUTURES ON SECURITIES. A futures contract on a security is a binding contractual
commitment which, if held to maturity, will result in an obligation to make or
accept delivery, during a particular month, of securities having a standardized
face value and rate of return. Futures contracts, by law are not permitted on
individual corporate securities and municipal securities but instead are traded
on exempt securities, such as government securities and broad-based indexes of
securities. Accordingly, these futures contracts will primarily consist of
futures based on government securities (i.e., Treasury Bonds). By purchasing
futures on securities, the Fund will legally obligate itself to accept delivery
of the underlying security and pay the agreed price; by selling futures on
securities, it will legally obligate itself to make delivery of the security
against payment of the agreed price. Open futures positions on securities are
valued at the most recent settlement price, unless such price does not reflect
the fair value of the contract, in which case the positions will be valued by or
under the direction of the Board of Directors.
Positions taken in the futures markets are not normally held to maturity, but
are instead liquidated through offsetting transactions which may result in a
profit or a loss. While the series' futures contracts on securities will usually
be liquidated in this manner, it may instead make or take delivery of the
underlying securities whenever it appears economically advantageous for the
series to do so. However, the loss from investing in futures transactions is
potentially unlimited. A clearing corporation associated with the exchange on
which futures on securities or currency are traded guarantees that, if still
open, the sale or purchase will be performed on the settlement date.
FOREIGN CURRENCY TRANSACTIONS. In order to protect against a possible loss on
investments resulting from a decline in a particular foreign currency against
the U.S. dollar or another foreign currency, each series is authorized to enter
into forward foreign currency exchange contracts. In addition, each series is
authorized to conduct spot (i.e., cash basis) currency transactions or to use
currency futures contracts, options on such futures contracts, and options on
foreign currencies in order to protect against uncertainty in the future levels
of currency exchange rates.
FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS. Forward foreign currency exchange
contracts involve an obligation to purchase or sell a specified
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currency at a future date at a price set at the time of the contract. Forward
currency contracts do not eliminate fluctuations in the values of portfolio
securities but rather allow a series to establish a rate of exchange for a
future point in time. A series may enter into forward foreign currency exchange
contracts when deemed advisable by the Advisor under only two circumstances.
First, when entering into a contract for the purchase or sale of a security in a
foreign currency, a series may enter into a forward foreign currency exchange
contract for the amount of the purchase or sale price to protect against
variations, between the date the security is purchased or sold and the date on
which payment is made or received, in the value of the foreign currency relative
to the U.S. dollar or other foreign currency. This hedging technique is known as
"transaction hedging".
Second, when the Advisor anticipates that a particular foreign currency may
decline substantially relative to the U.S. dollar or other leading currencies,
in order to reduce risk, a series may enter into a forward contract to sell, for
a fixed amount, the amount of foreign currency approximating the value of some
or all of its portfolio securities denominated in such foreign currency. This
hedging technique is known as "position hedging". With respect to any such
forward foreign currency contract, it will not generally be possible to match
precisely the amount covered by that contract and the value of the securities
involved due to the changes in the values of such securities resulting from
market movements between the date the forward contract is entered into and the
date it matures. In addition, while forward contracts may offer protection from
losses resulting from declines in the value of a particular foreign currency,
they also limit potential gains which might result from increases in the value
of such currency. A series will also incur costs in connection with forward
foreign currency exchange contracts and conversions of foreign currencies and
U.S. dollars.
A separate account of each series consisting of cash or liquid securities equal
to the amount of that series' assets that would be required to consummate
forward contracts entered into under the second circumstance, as set forth
above, will be established. For the purpose of determining the adequacy of the
securities in the account, the deposited securities will be valued at market or
fair value. If the market or fair value of such securities declines, additional
cash or securities will be placed in the account daily so that the value of the
account will equal the amount of such commitments by such series.
CURRENCY FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS. Each series, is
authorized to purchase and sell currency futures contracts and options thereon.
Currency futures contracts involve entering into contracts for the purchase or
sale for future delivery of foreign currencies. A "sale" of a currency futures
contract (i.e., short) means the acquisition of a contractual obligation to
deliver the foreign currencies called for by the contract at a specified price
on a specified date. A "purchase" of a futures contract (i.e., long) means the
acquisition of a contractual obligation to acquire the foreign currencies called
for by the contract at a specified price on a specified date. These investment
techniques will be used only to hedge against anticipated future changes in
exchange rates which otherwise might either adversely affect the value of
portfolio securities held by the series
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or adversely affect the prices of securities which the series intend to purchase
at a later date. The loss from investing in futures transactions is potentially
unlimited. To minimize this risk, such instruments will be used only in
connection with permitted transaction or position hedging and not for
speculative purposes. The series will not enter in a currency futures contract
or option thereon, if as a result thereof, the sum of the amount of initial
margin deposits on any such futures (plus deposits on any other futures
contracts and premiums paid in connection with any options or futures contracts)
that do not constitute "bona fide hedging" under CFTC rules will not exceed 5%
of the liquidation value of the series' total assets after taking into account
unrealized profits and losses on such contracts. In addition, the value of all
futures contracts sold will not exceed the total market value of the series'
portfolio. The series will comply with guidelines established by the SEC with
respect to covering of obligations under future contracts and will set aside
cash and/or liquid securities in a separate account in the amount prescribed.
Although the series intend to purchase or sell futures contracts only if there
is an active market for such contracts, no assurance can be given that a liquid
market will exist for any particular contract at any particular time. In
addition, due to the risk of an imperfect correlation between securities in the
series' portfolio that are the subject of a hedging transaction and the futures
contract used as a hedging device, it is possible that the hedge will not be
fully effective. For example, losses on the portfolio securities may be in
excess of gains on the futures contract or losses on the futures contract may be
in excess of the gains on the portfolio securities that were the subject of such
hedge.
Brokerage fees are incurred when a futures contract is bought or sold and margin
deposits must be maintained for such contract. Although futures contracts
typically require actual delivery of and payment for financial instruments or
currencies, the contracts are usually closed out before the delivery date.
Closing out an open futures contract sale or purchase is effected by entering
into an offsetting futures contract purchase or sale, respectively, for the same
aggregate amount of the identical type of financial instrument or currency and
the same delivery date. If the offsetting purchase price is less than the
original sale price, a series realizes a gain; if it is more, a series realizes
a loss. Conversely, if the offsetting sale price is more than the original
purchase price, a series realizes a gain; if it is less, a series realizes a
loss. Transaction costs must also be included in these calculations. There can
be no assurance, however, that a series will be able to enter into an offsetting
transaction with respect to a particular contract at a particular time. If a
series is not able to enter into an offsetting transaction, a series will
continue to be required to maintain the margin deposits on the contract. The
ability to establish and close out positions on such options will be subject to
the development and maintenance of a liquid secondary market. It is not certain
that a liquid market will develop for any particular futures contracts. See
"Certain Risk and Other Factors Respecting Options" above for possible reasons
for the absence of a liquid secondary market on an exchange.
An option on a futures contract gives the purchaser the right, in return for the
premium paid, to assume a position in a futures contract (a long position if a
call option and a short position if a put option) at a specified price at
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any time during the option exercise period. The writer of the option is required
upon exercise to assume an offsetting futures position (a short position if a
call option and a long position if a put option). Upon exercise of the option,
the assumption of offsetting futures positions by the writer and holder of the
option will be accompanied by delivery of the accumulated cash balance in the
writer's futures margin account which represents the amount by which the market
price of the futures contract, at exercise, 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
futures contract.
Call options sold by the series with respect to futures contracts will be
covered by, among other things, entering into a long position in the same
contract at a price no higher than the strike price of the call option, or by
ownership of the instruments underlying the futures contract, or the placement
of liquid assets in a segregated account to fulfill the obligations undertaken
by the futures contract. A put option sold by the series is covered when, among
other things, liquid assets are placed in a segregated account to fulfill the
obligations undertaken.
FOREIGN CURRENCY OPTIONS. Each series is authorized to purchase and write put
and call options on foreign currencies. A call option is a contract whereby the
purchaser, in return for a premium, has the right, but not the obligation, to
buy the currency underlying the option at a specified price during the exercise
period. The writer of the call option, who receives the premium, has the
obligation, upon exercise of the option during the exercise period, to deliver
the underlying 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 currency at a specified price during the term of the option.
The writer of the put option, who receives the premium, has the obligation, upon
exercise of the option during the option period, to buy the underlying currency
at the exercise price. The series will use currency options only to hedge
against the risk of fluctuations of foreign exchange rates related to securities
held in its portfolio or which it intends to purchase, and to earn a high return
by receiving a premium for writing options. Options on foreign currencies are
affected by all the factors which influence foreign exchange rates and
investments generally.
RISKS ASSOCIATED WITH HEDGING STRATEGIES. There are risks associated with the
hedging strategies described above, including the following: (1) the success of
a hedging strategy may depend on the ability of the Advisor to accurately
predict movements in the prices of individual securities, fluctuations in
domestic and foreign markets and currency exchange rates, and movements in
interest rates; (2) there may be an imperfect correlation between the changes in
market value of the securities held by the series and the prices of currency
contracts, options, futures and options on futures; (3) there may not be a
liquid secondary market for a currency contract, option, futures contract or
futures option; (4) trading restrictions or limitations may be imposed by an
exchange; and (5) government regulations, particularly requirements for
qualification as a "regulated investment company" under the Code, may restrict
trading in forward currency contracts, options, futures contracts and futures
options.
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Even a small investment in derivative contracts can have a big impact on stock
market, currency and interest rate exposure. Derivatives can also make a series
less liquid and harder to value, especially in declining markets.
OTHER INVESTMENT POLICIES
FOREIGN SECURITIES. Each series may invest up to 25% of its assets in foreign
securities which are not publicly traded in the United States. The series'
investments in foreign securities will be of the same types and quality as the
domestic securities in which the series may invest when the anticipated
performance of foreign securities is believed by the Advisor to offer more
potential than domestic alternatives in keeping with the investment goals of the
series. Each series will invest no more than 25% of its assets in securities
issued by any one foreign government. Each series may invest without limit in
equity securities of foreign issuers that are listed on a domestic securities
exchange or are represented by American Depository Receipts that are listed on a
domestic securities exchange or are traded in the United States on the
over-the-counter market. Foreign debt securities may be denominated either in
U.S. dollars or foreign currencies.
Each series' restrictions on investment in foreign securities are fundamental
policies that cannot be changed without the approval of a majority, as defined
in the Investment Company Act of 1940 (the "1940 Act"), of the outstanding
voting securities of the series.
There are risks in investing in foreign securities not typically involved in
domestic investing. An investment in foreign securities may be affected by
changes in currency rates and in exchange control regulations. Foreign companies
are frequently not subject to the accounting and financial reporting standards
applicable to domestic companies, and there may be less information available
about foreign issuers. There is frequently less government regulation of foreign
issuers than in the United States. In addition, investments in foreign countries
are subject to the possibility of expropriation or confiscatory taxation,
political or social instability or diplomatic developments that could adversely
affect the value of those investments. There may also be imposition of
withholding taxes. Foreign financial markets may have less volume and longer
settlement periods than U.S. markets which may cause liquidity problems for a
series. In addition, costs associated with transactions on foreign markets are
generally higher than for transactions in the U.S. These risks generally are
greater for investments in securities of companies in emerging markets, which
are usually in the initial stages of their industrialization cycle.
Obligations of foreign governmental entities are subject to various types of
governmental support and may or may not be supported by the full faith and
credit of a foreign government.
CURRENCY RISKS. The U.S. dollar value of securities denominated in a foreign
currency will vary with changes in currency exchange rates, which can be
volatile. Accordingly, changes in the value of the currency in which a series'
investments are denominated relative to the U.S. dollar will affect the series'
net asset value. Exchange rates are generally affected by the forces of supply
and demand in the international currency markets, the relative merits of
investing in different countries and the intervention or
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failure to intervene of U.S. or foreign governments and central banks. However,
currency exchange rates may fluctuate based on factors intrinsic to a country's
economy. Some emerging market countries also may have managed currencies, which
are not free floating against the U.S. dollar. In addition, emerging markets are
subject to the risk of restrictions upon the free conversion of their currencies
into other currencies. Any devaluations relative to the U.S. dollar in the
currencies in which a series' securities are quoted would reduce the series' net
asset value per share.
REPURCHASE AGREEMENTS. Each series may enter into repurchase agreements with
respect to portfolio securities. Under the terms of a repurchase agreement, the
series purchases securities ("collateral") from various financial institutions
such as a bank or broker-dealer (a "seller") which the Advisor deems to be
creditworthy, subject to the seller's agreement to repurchase them at a mutually
agreed-upon date and price. The repurchase price generally equals the price paid
by the series plus interest negotiated on the basis of current short-term rates
(which may be more or less than the rate on the underlying portfolio
securities).
The seller under a repurchase agreement is required to maintain the value of the
collateral held pursuant to the agreement at not less than 100% of the
repurchase price, and securities subject to repurchase agreements are held by
the series' custodian either directly or through a securities depository.
Default by the seller would, however, expose the series to possible loss because
of adverse market action or delay in connection with the disposition of the
underlying securities. Repurchase agreements are considered to be loans by the
series under the 1940 Act.
SECURITIES LENDING. Each series may seek to increase its income by lending
portfolio securities. Such loans will usually be made to member firms (and
subsidiaries thereof) of the New York Stock Exchange and to member banks of the
Federal Reserve System, and would be required to be secured continuously by
collateral in liquid securities maintained on a current basis at an amount at
least equal to the market value of the securities loaned. If the Advisor
determines to make securities loans, the value of the securities loaned would
not exceed 30% of the value of the total assets of the series.
SHORT SALES. Each series may, within limits, engage in short sales "against the
box". A short sale is the sale of borrowed securities; a short sale against the
box means that a series owns securities equivalent to those sold short. No more
than 25% of the net assets (taken at current value) of a series may be held as
collateral for such sales at any one time. Such short sales can be used as a
hedge. The Fund has no current intention to engage in short sales against the
box.
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FORWARD COMMITMENTS OR PURCHASES ON A WHEN-ISSUED BASIS. Each series may enter
into forward commitments or purchase securities on a when-issued basis. These
securities normally are subject to settlement within 45 days of the purchase
date. The interest rate realized on these securities is fixed as of the purchase
date and no interest accrues to the series before settlement. These securities
are subject to market fluctuation due to changes in market interest rates. Each
series will enter into these arrangements with the intention of acquiring the
securities in question and not for speculative purposes and will maintain a
separate account consisting of liquid assets in an amount at least equal to the
purchase price.
INVESTMENT IN RESTRICTED SECURITIES. Each series may invest in "restricted
securities" subject to the 10% net asset limitation regarding illiquid
securities. Restricted securities are securities which were originally sold in
private placements and which have not been registered under the Securities Act
of 1933, as amended (the "1933 Act"). Such securities generally have been
considered illiquid because they may be resold only subject to statutory
restrictions and delays or if registered under the 1933 Act. The SEC adopted
Rule 144A to provide for a safe harbor exemption from the registration
requirements of the 1933 Act for resales of restricted securities to "qualified
institutional buyers." The result has been the development of a more liquid and
efficient institutional resale market for restricted securities. Rule 144A
securities may be liquid if properly determined by the Board of Directors.
MANAGEMENT OF REALIZATION EVENTS (TAX MANAGED SERIES). The Tax Managed Series'
portfolio will be actively managed to minimize both the number and amount of
realization events. The following methods are used:
SPECIFIC IDENTIFICATION OF SECURITY SHARES SOLD - Federal income tax law
allows the series to specify which shares of stock the series will treat as
being sold. The series will individually analyze which shares to sell. The
following example will further explain the technique:
During year 1, the series purchases 100 shares of XYZ Corp on two
separate occasions. The first purchase of 100 shares cost $10/share
and the second purchase of 100 shares cost $12.50/share. In year 2,
the series decides to sell 100 shares of XYZ Corp at $15/share. If the
series used a First-in, First-out (FIFO) method, the realized gain
would be $500, but since the series analyzes each sale, the shares
with a cost of $12.50/share would have been sold, resulting in a
realized gain of only $250. This would have resulted in a deferral of
tax of $99 using a marginal tax rate of 39.6%.
Deferring amount of gain (or accelerating loss) realized on each sale is
maximized by the use of the Highest-In, First-Out (HIFO) method of
identifying which shares to sell. The expectation is that any capital gain
is minimized (or capital loss is maximized) since the difference between
the proceeds on the sale of the shares and the cost of those shares is also
minimized. However, if the series has a loss to offset, low-cost securities
may be sold for profit and may also then be reacquired in order to "step
up" the basis in those securities. There will be times when it will be more
advantageous for the series to identify shares without the highest cost.
This may occur, for example, when shares with the highest
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cost result in the realization of short-term capital gains while shares
with a lower cost result in a long-term gain. Since short-term capital
gains are generally subject to higher rates of tax, the lower cost may be
chosen due to the tax benefits of the lower tax rate.
MANAGEMENT OF DIVIDEND DISTRIBUTIONS (TAX MANAGED SERIES). The Tax Managed
Series will minimize dividend distributions to the extent permitted to maintain
regulated investment company status under the Code. The following methods are
used:
EQUALIZATION ACCOUNTING - Under current law, the series intends, for tax
purposes, to treat as a distribution of investment company taxable income
or net capital gain the portion of redemption proceeds paid to redeeming
shareholders that represents the redeeming shareholders' portion of the
series' undistributed investment company taxable income and net capital
gain. This practice will have the effect of reducing the amount of income
and gains that the series is required to distribute as dividends to
shareholders in order for the series to avoid federal income and excise
tax. This practice may also reduce the amount of distributions required to
be made to non-redeeming shareholders and defer the recognition of taxable
income by such shareholders. However, since the amount of any undistributed
income will be reflected in the value of the series' shares, the total
return on a shareholder's investment will not be reduced as a result of the
series' distribution policy. Under the Code, equalization payments may be
used in lieu of dividend distributions of either ordinary taxable income or
net capital gains. The series will designate equalization payments as being
made in lieu of ordinary taxable dividends before net capital gains. The
series' use of equalization accounting will not affect the tax treatment of
shareholders that redeem their shares with respect to such redemptions.
DELIBERATE MINIMIZATION OF CASH DIVIDENDS - The series will minimize the
amount it distributes as ordinary income dividends. It may not, therefore,
distribute all investment company taxable income or ordinary income. It
will, however, distribute dividends sufficient to maintain its status as a
regulated investment company. In addition, the series may retain income
for excise tax purposes (and then incur excise tax) if it anticipates such
retention will enhance shareholders' after-tax total returns.
INVESTMENT RESTRICTIONS
Each series has adopted certain restrictions set forth below as fundamental
policies, which may not be changed without the favorable vote of the holders of
a "majority" of the Fund's outstanding voting securities, which means a vote of
the holders of the lesser of (i) 67% of the shares represented at a meeting at
which more than 50% of the outstanding shares are represented or (ii) more than
50% of the outstanding shares.
None of the series may:
1. Borrow money, except from a bank for temporary or emergency purposes in
amounts not exceeding 10% of the series' total assets, and the series will not
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make additional investments while borrowings greater than 5% of its total assets
are outstanding;
2. With respect to 75% of its total assets, invest more than 5% of the value of
its total assets at the time of investment in securities of any one issuer
(other than obligations issued or guaranteed by the United States Government,
its agencies or its instrumentalities). None of the series may purchase more
than 10% of the outstanding voting securities of any one issuer;
3. Invest 25% or more of the value of its total assets in securities of issuers
in any one industry (other than U.S. government Securities);
4. Invest more than 10% of its total net assets in securities of issuers that
are restricted from being sold to the public without registration under the
Securities Act of 1933 and illiquid securities, including repurchase agreements
with maturities of greater than seven days;
5. Purchase shares of closed-end investment companies that are traded on
national exchanges, except to the extent permitted by applicable law;
6. Make loans, except that each may invest in debt securities and repurchase
agreements and may engage in securities lending;
7. Purchase securities on margin (but a series may obtain such short-term
credits as may be necessary for the clearance of transactions);
8. Make short sales of securities or maintain a short position, unless at all
times when a short position is open it owns an equal amount of such securities
or securities convertible into or exchangeable, without payment of any further
consideration, for securities of the same issue as, and equal in amount to, the
securities sold short (short sale against-the-box), and unless not more than 25%
of a series' net assets (taken at a current value) are held as collateral for
such sales at any one time;
9. Issue senior securities or pledge its assets, except that each series may
invest in futures contracts and related options;
10. Buy or sell commodities or commodity contracts (the Tax Managed Series
also expressly provides that forward foreign currency contracts are not
considered commodities or commodity contracts for purposes of this
restriction) or real estate or interest in real estate, although it may
purchase and sell securities which are secured by real estate and securities
of companies which invest or deal in real estate. The Blended Asset Series I,
Blended Asset Series II, Flexible Yield Series I, Flexible Yield Series II,
Flexible Yield Series III, Defensive Series, Maximum Horizon Series, and
PureMark-SM- Series may not buy or sell commodities or commodity contracts,
provided that the series may enter into all types of futures and forward
contracts on currency, securities, economic and other indices and may
purchase and sell options on such futures contracts, or buy or sell real
estate or interests in real estate, although it may purchase and sell
securities which are secured by real estate and securities of companies which
invest or deal in real estate.
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11. Act as underwriter except to the extent that, in connection with the
disposition of portfolio securities, it may be deemed to be an underwriter under
certain federal securities laws;
12. Make investments for the purpose of exercising control or management;
13. Participate on a joint or joint and several basis in any trading account in
securities;
14. Invest in interests in oil, gas or other mineral exploration or development
programs, although it may invest in the common stocks of companies which invest
in or sponsor such programs;
15. Purchase foreign securities if as a result of the purchase of such
securities more than 25% of a series' assets would be invested in foreign
securities provided that this restriction shall not apply to foreign securities
that are listed on a domestic securities exchange or represented by American
depository receipts that are traded either on a domestic securities exchange or
in the United States on the over-the-counter market;
16. Invest more than 5% of the value of its total net assets in warrants
(except for the Flexible Yield Series I, Flexible Yield Series II, Flexible
Yield Series III, and the PureMark-SM- Series). Included within that amount,
but not to exceed 2% of the value of the series' net assets, may be warrants
which are not listed on the New York or American Stock Exchange.
In addition to the foregoing:
17. The Defensive Series, the Maximum Horizon Series, the Tax Managed Series,
and the PureMark-SM- Series may not invest assets in securities of any other
open-end investment company, except (1) by purchase in the open market
involving only customary brokers' commissions, (2) in connection with
mergers, acquisitions of assets, or consolidation, or (3) as otherwise
permitted by law, including the 1940 Act.
18. Under the Investment Company Act of 1940 and the rules and regulations
thereunder, each series is prohibited from acquiring the securities of other
investment companies if, as a result of such acquisition, such series owns
more than 3% of the total voting stock of the company; securities issued by
any one investment company represent more than 5% of its total assets; or
securities (other than treasury stock) issued by all investment companies
represent more than 10% of the total assets of a series. A series' purchase
of such investment companies would indirectly bear a proportionate share of
the operating expenses of such investment companies, including advisory fees.
None of the series, except the Defensive Series, the Maximum Horizon Series,
the Tax Managed Series, and the PureMark-SM- Series will purchase or retain
securities issued by open-end investment companies (other than money market
funds for temporary investment).
19. The Fund's investment policies with respect to options on securities and
with respect to stock index and currency futures and related options (except
for the PureMark-SM- Series) are subject to the following fundamental
limitations: (1) with respect to any series, the aggregate value of the
securities underlying calls or obligations underlying puts determined as of
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the date options are sold shall not exceed 25% of the assets of the series; (2)
a series will not enter into any option transaction if immediately thereafter,
the aggregate premiums paid on all such options which are held at any time would
exceed 20% of the total net assets of the series; (3) the aggregate margin
deposits required on all futures or options thereon held at any time by a series
will not exceed 5% of the total assets of the series; (4) the security
underlying the put or call is within the investment policies of each series and
the option is issued by the Options Clearing Corporations; and (5) the series
may buy and sell puts and calls on securities and options on financial futures
if such options are listed on a national securities or commodities exchange.
20. The Fund will not purchase or retain securities of an issuer if an officer
or director of such issuer is an officer or director of the Fund or its
investment adviser and one or more of such officers or directors of the Fund or
its investment adviser owns beneficially more than 1/2% of the shares or
securities of such issuer and all such directors and officers owning more than
1/2% of such shares or securities together own more than 5% of such shares or
securities.
21. The Fund will not purchase securities of any company which has (with
predecessors) a record of less than three years continuous operation if as a
result more than 5% of the series' assets would be invested in securities of
such companies.
PORTFOLIO TURNOVER
An annual portfolio turnover rate is, in general, the percentage computed by
taking the lesser of purchases or sales of portfolio securities (excluding
certain debt securities) for a year and dividing that amount by the monthly
average of the market value of such securities during the year. Each series
expects that its long-term average turnover rate will be less than 100%.
However, turnover will in fact be determined by market conditions and
opportunities, and therefore it is impossible to estimate the turnover rate with
confidence.
THE FUND
The Fund is an open-end management investment company incorporated under the
laws of the State of Maryland on July 26, 1984. Prior to February 1998, the Fund
was named Manning & Napier Fund, Inc. The Board of Directors may, at its own
discretion, create additional series of shares, each of which would have
separate assets and liabilities.
Each share of a series represents an identical interest in the investment
portfolio of that series and has the same rights, except that (i) each class of
shares bears those distribution fees, service fees and administrative expenses
applicable to the respective class of shares as a result of its sales
arrangements, which will cause the different classes of shares to have different
expense ratios and to pay different rates of dividends, (ii) each class has
exclusive voting rights with respect to those provisions of the series' Rule
12b-1 distribution plan which relate only to such class and (iii) the classes
have different exchange privileges. As a result of each class' differing Rule
12b-1 distribution and shareholder services plan, shares of
26
<PAGE>
different classes of the same series may have different net asset values per
share.
The Fund does not expect to hold annual meetings of shareholders but special
meetings of shareholders may be held under certain circumstances. Shareholders
of the Fund retain the right, under certain circumstances, to request that a
meeting of shareholders be held for the purpose of considering the removal of a
Director from office, and if such a request is made, the Fund will assist with
shareholder communications in connection with the meeting. The shares of the
Fund have equal rights with regard to voting, redemption and liquidations. The
Fund's shareholders will vote in the aggregate and not by series or Class except
as otherwise expressly required by law or when the Board of Directors determines
that the matter to be voted upon affects only the interests of the shareholders
of a series or a Class. Income, direct liabilities and direct operating expenses
of a series will be allocated directly to the series, and general liabilities
and expenses of the Fund will be allocated among the series in proportion to the
total net assets of the series by the Board of Directors. The holders of shares
have no preemptive or conversion rights. Shares when issued are fully paid and
non-assessable and do not have cumulative voting rights.
27
<PAGE>
MANAGEMENT
The overall business and affairs of the Fund are managed by the Fund's Board of
Directors. The Board approves all significant agreements between the Fund and
persons or companies furnishing services to the Fund, including the Fund's
agreements with its investment advisor, custodian and distributor. The
day-to-day operations of the Fund are delegated to the Fund's officers and to
the Advisor. A committee made up of investment professionals and analysts makes
all the investment decisions for the Fund.
The Directors and officers of the Fund are:
<TABLE>
<CAPTION>
Position Principal occupations
Name, address, date of birth with Fund during past five years
- ---------------------------- --------- ----------------------
<S> <C> <C>
B. Reuben Auspitz* Vice Executive Vice President, Manning
1100 Chase Square President & & Napier Advisors, Inc. since 1983;
Rochester, NY 14604 Director President and Director, Manning &
03/18/47 Napier Investor Services, Inc. since
1990; Director, Chairman and
Treasurer, Manning & Napier Advisory
Advantage Corporation since 1990;
Director, Manning & Napier Leveraged
Investing Co., Inc. since 1994; Director and Chairman,
Exeter Trust Co. since 1994; Member, Qualified Plan
Services, L.L.C. (formerly known as Fiduciary Services,
L.L.C.)since 1995; Member, Manning & Napier Associates,
L.L.C. since 1995; Member, Manning & Napier Capital Co.,
L.L.C. since 1995; President and Director, Manning &
Napier Insurance Fund, Inc. since 1995; Managing
Director, Manning & Napier Advisors, Inc. from 1983-1992
Martin Birmingham Director Trustee, The Freedom Forum, since 1980;
21 Brookwood Road Director, Emeritus, ACC Corporation
Pittsford, NY 14534 since 1994; Director, Manning & Napier
10/30/21 Insurance Fund, Inc. since 1995
Harris H. Rusitzky Director President, Blimpie of Central New York and The Greening
One Grove Street Group since 1994; Director, Manning & Napier Insurance
Pittsford, NY 14534 Fund, Inc. since 1995
01/09/35
Peter L. Faber Director Former Partner, Kaye, Scholer, Fierman,
50 Rockefeller Plaza Hays & Handler from 1984-1995; Partner
New York, New York 10020-1605 McDermott, Will & Emery since 1995;
04/29/38 Director, Manning & Napier Insurance
Fund, Inc. since 1995
</TABLE>
28
<PAGE>
<TABLE>
<S> <C> <C>
Stephen B. Ashley Director Chairman and Chief Executive Officer,
600 Powers Building The Ashley Group since 1975;
16 West Main Street Director, Genesee Corp. since
Rochester, New York 14614 1987; Director, Hahn Automotive since
03/22/40 1994; Director, Fannie Mae since 1995;
Director, Manning & Napier Insurance
Fund, Inc. since 1996
William Manning President President, Director and co-founder,
1100 Chase Square Manning & Napier Advisors, Inc. since
Rochester, NY 14604 1970; President, Director,
12/24/36 Founder & CEO, Manning Ventures, Inc.
since 1992; President, Director,
Founder & CEO, KSDS, Inc. since 1992;
Chairman of the Board, Director, CEO,
Kent Displays, Inc. since 1992;
President, Director,Founder & CEO,
Synmatix Corporation since 1993;
President, Director, Founder & CEO,
Manning Leasing, Inc.(dba Williams
International Air, Inc.)since 1994;
President and Treasurer, Manning &
Napier Leveraged InvestingCompany, Inc.
since 1994; Member, Manning & Napier
Capital Co., L.L.C. since 1994; Member,
Qualified Plan Services, L.L.C
(formerly known as Fiduciary Services,
L.L.C.) since 1995; Member, Manning & Napier Associates,
L.L.C. since 1995; Director, CEO, President and Founder,
Burgandy Car Service, Inc. 1996 to 1997;Director, CEO,
President and Founder,BCS Leasing, Inc. since 1996
Beth H. Galusha, CPA Chief Chief Financial Officer, Manning &
1100 Chase Square Financial & Napier Advisors, Inc. since 1987;
Rochester, NY 14604 Accounting Treasurer, Manning & Napier Investor
06/23/61 Officer, Services, Inc. since 1990; Director,
Treasurer Manning & Napier Advisory Advantage
Corporation since 1993; Treasurer, Exeter Trust Company
since 1997; Chief Financial & Accounting Officer,
Treasurer, Manning & Napier Insurance Fund, Inc. since
1997
Jodi L. Hedberg Corporate Senior Compliance Administrator,
1100 Chase Square Secretary Manning & Napier Advisors, Inc. from
Rochester, NY 14604 1994-1995; Compliance Manager, Manning
11/26/67 & Napier Advisors, Inc. since 1995;
Corporate Secretary, Manning & Napier
Insurance Fund, Inc. since 1997.
</TABLE>
29
<PAGE>
* Interested Director, within the meaning of the Investment Company Act of 1940
(the "1940 Act").
The only Committee of the Fund is an Audit Committee whose members are B. Reuben
Auspitz, Harris H. Rusitzky and Stephen B. Ashley.
Directors affiliated with the Advisor do not receive fees from the Fund. Each
Director who is not affiliated with the Advisor shall receive an annual fee of
$2,500. Annual fees will be calculated monthly and prorated. Each Director who
is not affiliated with the Advisor shall receive $375 per Board Meeting attended
for each active series of the Fund, plus $500 for any Committee Meeting held on
a day on which a Board Meeting is not held.
COMPENSATION TABLE FOR FISCAL YEAR ENDED OCTOBER 31, 1998
<TABLE>
<CAPTION>
Estimated
Annual Total
Benefits Compensation
Position from Aggregate upon from
Name Registrant Compensation Pension Retirement Registrant
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
B. Reuben Auspitz* Director $0 N/A N/A $0
Martin Birmingham Director $25,000 N/A N/A $25,000
Harris H. Rusitzky Director $25,500 N/A N/A $25,500
Peter L. Faber Director $25,000 N/A N/A $25,000
Stephen B. Ashley Director $25,500 N/A N/A $25,500
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
*Interested Director, within the meaning of the Investment Company Act of 1940
(the "1940 Act").
The following persons were known by the Fund to be owner of record 5% or more of
the outstanding voting securities of each series on April 26, 1999.
<TABLE>
<CAPTION>
NAME AND ADDRESS OF HOLDER OF RECORD PERCENTAGE OF SERIES
- ------------------------------------ --------------------
BLENDED ASSET SERIES I
<S> <C>
National Financial Services Corp. 16.22%
FBO Customers
200 Liberty Street
New York, NY 10281-1003
</TABLE>
30
<PAGE>
<TABLE>
<S> <C>
American Express Trustee for 14.22%
Morton Mease Health Care Trust
1200 Northstar West
Minneapolis, MN 55440-0534
Exeter Trust Co. 9.88%
FBO Welch Foods, Inc.
P.O. Box 41178
Rochester, NY 14604
<CAPTION>
BLENDED ASSET SERIES II
<S> <C>
National Financial Services Corp. 18.70%
FBO Customers
200 Liberty Street
New York, NY 10281-1003
<CAPTION>
FLEXIBLE YIELD SERIES I
<S> <C>
A.V. Durand Profit Sharing Plan 24.58%
c/o Albert V. Durand
9 Landsdowne Lane
Rochester, NY 14618
Mark A. Kronenberg 16.50%
7814 NewCo Drive
Hamlin, NY 14464
Machined Products Co. 14.58%
c/o Kathleen Saul
P.O. Box 10428
Lancaster, PA 17605
Manning & Napier Advisors, Inc. 9.16%
1100 Chase Square
Rochester, NY 14604
Endicott Machine and Tool Company, Inc. 7.36%
c/o Wyoma Chambala
101 Delaware Avenue
Endicott, NY 13760
John G. Napier 7.08%
33 Beard Avenue
Buffalo, NY 14214
Berniece I. Gosnell 5.03%
c/o Dawn Hilsinger
319 Dearcop Drive
Rochester, NY 14624
</TABLE>
31
<PAGE>
<TABLE>
<CAPTION>
FLEXIBLE YIELD SERIES II
<S> <C>
Manning & Napier Advisors, Inc. 25.52%
1100 Chase Square
Rochester, NY 14604
Charles E. Lucas IRA Rollover 16.02%
9 Southland Avenue
Lakewood, NY 14750
Penfield Fire Company 7.15%
1838 Penfield Road
Penfield, NY 14526
Jerry J. Vasicek IRA Rollover 7.10%
65 Coventry Road
Endicott, NY 13760
R. Sheldon and Marie E. Starr JTWROS 6.88%
798 Starr Avenue
Chambersburg, PA 17201
June Dahlin & Richard Dahlin JTWROS 5.39%
1425 2nd Avenue
Chula Vista, CA 91911
<CAPTION>
FLEXIBLE YIELD SERIES III
<S> <C>
Machined Products Co. 401(k) 13.07%
c/o Kathleen Saul
P.O. Box 10428
Lancaster, PA 17605
Manning & Napier Advisors, Inc. 12.03%
1100 Chase Square
Rochester, NY 14604
Walter D. and Beth H. Kogut JTWROS 6.86%
8066 Irish Mist Lane
Manlius, NY 13104
Hoselton Foundation 6.20%
c/o Mr. David Hoselton
909 Fairport Rd.
E. Rochester, NY 14445
Boy Scouts of America Troop 31 5.64%
c/o Mr. David Hoselton
909 Fairport Rd.
E. Rochester, NY 14445
Peter L. Kogut Jr. and Christine Kogut JTWROS 5.32%
</TABLE>
32
<PAGE>
<TABLE>
<CAPTION>
<S> <C>
77 Old Stonefield Way
Pittsford, NY 14534
<CAPTION>
TAX MANAGED SERIES
<S> <C>
Manning & Napier Advisors, Inc. 22.11%
1100 Chase Square
Rochester, NY 14604
Reuben A. Sheares 14.51%
762 Greenhurst Drive
Westerville, OH 43082
Kay B. Sharp Bypass Trust 12.10%
David P. Evans, Trustee
2732 Seneca Street
P.O. Box 527
West Seneca, NY 14224
Jacob I. Rabin UTMA-OH 8.08%
c/o Michael I. Rabin
938 Chestnut Run
Gates Mills, OH 44040
<CAPTION>
DEFENSIVE SERIES
<S> <C>
National Financial Services Corp. 35.96%
FBO Customers
200 Liberty Street
New York, NY 10281-1003
Plumbers Local 55 Benevolent Fund 10.55%
c/o James F. Sullivan
980 Keynote Circle
Brooklyn Heights, OH 44131
Plumbers Local 55 S.U.B. Fund 6.69%
c/o James F. Sullivan
980 Keynote Circle
Brooklyn Heights, OH 44131
Manning & Napier Advisors, Inc. 6.38%
1100 Chase Square
Rochester, NY 14604
</TABLE>
33
<PAGE>
<TABLE>
<CAPTION>
MAXIMUM HORIZON SERIES
<S> <C>
National Financial Service Corp. 67.54%
FBO Customers
200 Liberty Street
New York, NY 10281-1003
</TABLE>
THE ADVISOR
The Advisor, Exeter Asset Management, which is a division of Manning & Napier
Advisors, Inc. ("MNA"), acts as the Series' investment advisor. Mr. William
Manning controls the Advisor by virtue of his ownership of the securities of
MNA. The Advisor also is generally responsible for supervision of the overall
business affairs of the Fund including supervision of service providers to the
Fund and direction of the Advisor's directors, officers or employees who may be
elected as officers of the Fund to serve as such.
The Fund pays the Advisor for the services performed a fee at the annual rate
of: 1.00% of the Fund's daily net assets for the Maximum Horizon Series, Tax
Managed Series, Blended Asset Series I, and Blended Asset Series II; 0.80%
for the Defensive Series; 0.35% for the Flexible Yield Series I; 0.45% for
the Flexible Yield Series II; and 0.50% for the Flexible Yield Series III and
PureMark -SM- Series. As described below, the Advisor is separately
compensated for acting as transfer agent for the series.
Under the Investment Advisory Agreement (the "Agreement") between the Fund and
the Advisor, the Fund is responsible for its operating expenses, including: (i)
interest and taxes; (ii) brokerage commissions; (iii) insurance premiums; (iv)
compensation and expenses of its Directors other than those affiliated with the
Advisor; (v) legal and audit expenses; (vi) fees and expenses of the Fund's
custodian, and accounting services agent, if obtained for the Fund from an
entity other than the Advisor; (vii) expenses incidental to the issuance of its
shares, including issuance on the payment of, or reinvestment of, dividends and
capital gain distributions; (viii) fees and expenses incidental to the
registration under federal or state securities laws of the Fund or its shares;
(ix) expenses of preparing, printing and mailing reports and notices and proxy
material to shareholders of the Fund; (x) all other expenses incidental to
holding meetings of the Fund's shareholders; (xi) dues or assessments of or
contributions to the Investment Company Institute or any successor; and (xii)
such non-recurring expenses as may arise, including litigation affecting the
Fund and the legal obligations with respect to which the Fund may have to
indemnify its officers and directors.
For periods ended October 31, (unless otherwise indicated), the aggregate total
of advisory fees paid by the series to the Advisor were as follows:
34
<PAGE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------------
Series 1996 1997 1998
--------------------------------------------------------------------------------------------------------
Fees Paid Fees Waived Fees Paid Fees Waived Fees Paid Fees Waived
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Blended Asset Series I $108,485 (1) $13,439(1) $192,773 $8,448 $274,475 $7,453
- -----------------------------------------------------------------------------------------------------------------------------------
Blended Asset Series II $222,302 (1) $3,528 (1) $422,101 N/A $633,708 N/A
- -----------------------------------------------------------------------------------------------------------------------------------
Flexible Yield Series I N/A $1,057 (1) N/A $2,189 N/A $2,058
- -----------------------------------------------------------------------------------------------------------------------------------
Flexible Yield Series II N/A $1,688 (1) N/A $2,897 N/A $2,639
- -----------------------------------------------------------------------------------------------------------------------------------
Flexible Yield Series III N/A $4,454 (1) N/A $6,249 N/A $7,221
- -----------------------------------------------------------------------------------------------------------------------------------
Tax Managed N/A $1,867 (2) N/A $3,368 N/A $7,011
- -----------------------------------------------------------------------------------------------------------------------------------
Defensive N/A $3,940 (2) N/A $11,283 $2,742 $27,614
- -----------------------------------------------------------------------------------------------------------------------------------
Maximum Horizon N/A $4,377 (2) 36,471 $19,683 $137,521 $19,276
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) For the period January 1, 1996 to October 31, 1996.
(2) For the period November 1, 1995 (Commencement of Operations) to October
31, 1996.
The Agreement provides that in the event the expenses of the Fund (including the
fee of the Advisor but excluding: (i)brokerage commissions; (ii) interest; (iii)
taxes; and (iv) extraordinary expenses except for those incurred by the Fund as
a result of litigation in connection with a suit involving a claim for recovery
by the Fund, or as a result of litigation involving a defense against a
liability asserted against the Fund, provided that, if the adviser made the
decision or took the action which resulted in such claim the adviser acted in
good faith without gross negligence or misconduct, and for any indemnification
paid by the Fund to its officers, directors and advisers in accordance with
applicable state and federal laws as a result of such litigation) for any fiscal
year exceed the limits set by applicable regulations of state securities
commissions, the Advisor will reduce its fee by the amount of such excess. Any
such reductions or refunds are accrued and paid in the same manner as the
Advisor's fee and are subject to readjustment during the year.
The Agreement states that the Advisor shall give the Fund the benefit of its
best judgment and effort in rendering services thereunder, but the Advisor shall
not be liable for any loss sustained by reason of the purchase, sale or
retention of any security, whether or not such purchase, sale or retention shall
have been based upon its own investigation and research or upon investigation
and research made by any other individual, firm or corporation, if such
purchase, sale or retention shall have been made and such other individual, firm
or corporation shall have been selected in good faith. The
35
<PAGE>
Agreement also states that nothing contained therein shall, however, be
construed to protect the Advisor against any liability to the Fund or its
security holders by reason of willful misfeasance, bad faith or gross negligence
in the performance of its duties, or by reason of its reckless disregard of its
obligations and duties under the Agreement.
The Agreement also provides that it is agreed that the Advisor shall have no
responsibility or liability for the accuracy or completeness of the Fund's
Registration Statement under the 1940 Act or the Securities Act of 1933 except
for information supplied by the Advisor for inclusion therein; the Fund agrees
to indemnify the Advisor to the full extent permitted by the Fund's Articles of
Incorporation.
On April 30, 1993, the Advisor became the Fund's Transfer Agent. For servicing
the Tax Managed Series, Defensive Series, Maximum Horizon Series, Blended Asset
Series I, Blended Asset Series II, Flexible Yield Series I, Flexible Yield
Series II, and the Flexible Yield Series III, in this capacity, for the fiscal
years ended October 31, 1997 and 1998, the Advisor received $17,331 and $27,446
from the Fund.
DISTRIBUTION OF FUND SHARES
Manning & Napier Investor Services, Inc. (the "Distributor") acts as Distributor
of the Fund shares and is located at the same address as the Advisor and the
Fund. The Distributor and the Fund are parties to a distribution agreement dated
May 11, 1999 (the "Distribution Agreement") which applies to each Class of
shares.
The Distribution Agreement will remain in effect for a period of two years after
the effective date of the agreement and is renewable annually. The Distribution
Agreement may be terminated by the Distributor, by a majority vote of the
Directors who are not interested persons and have no financial interest in the
Distribution Agreement ("Qualified Directors") or by a majority of the
outstanding shares of the Fund upon not more than 60 days' written notice by
either party or upon assignment by the Distributor. The Distributor will not
receive compensation for distribution of Class A shares of the Portfolio. The
Fund has adopted Plans of Distribution with respect to the Class B, C, D and E
Shares (the "Plans"), pursuant to Rule 12b-1 under the 1940 Act. The Advisor may
impose separate requirements in connection with employee purchases of the Class
A Shares of the series.
THE PLANS
The Fund has adopted each Plan in accordance with the provisions of Rule 12b-1
under the 1940 Act which regulates circumstances under which an investment
company may directly or indirectly bear expenses relating to the distribution of
its shares. Continuance of each Plan must be approved annually by a majority of
the Directors of the Fund and by a majority of the Qualified Directors. Each
Plan requires that quarterly written reports of amounts spent under the Plan and
the purposes of such expenditures be furnished to and reviewed by the Directors.
A Plan may not be amended to increase materially the amount which may be spent
thereunder without approval by a majority of the outstanding shares of the
respective class of the Fund. All material
36
<PAGE>
amendments of a Plan will require approval by a majority of the Directors of the
Fund and of the Qualified Directors.
The Distributor expects to allocate most of its fee to investment dealers, banks
or financial service firms that provide distribution, administrative and/or
shareholder services ("Financial Intermediaries"). The Financial Intermediaries
may provide for their customers or clients certain services or assistance, which
may include, but not be limited to, processing purchase and redemption
transactions, establishing and maintaining shareholder accounts regarding the
Fund, and such other services as may be agreed to from time to time and as may
be permitted by applicable statute, rule or regulation. The Distributor may, in
its discretion, voluntarily waive from time to time all or any portion of its
distribution fee and the Distributor is free to make additional payments out of
its own assets to promote the sale of Fund shares.
The Distributor receives distribution and/or service fees, at the rates set
forth below, for providing distribution and/or shareholder services to the Class
B, C, D and E Shares. The Distributor expects to allocate most of its
distribution fees and shareholder service fees to Financial Intermediaries that
enter into distribution and/or shareholder servicing agreements with the
Distributor. The different Classes permit the Fund to allocate an appropriate
amount of fees to a Financial Intermediary in accordance with the level of
distribution and/or shareholder services it agrees to provide.
As compensation for providing distribution and shareholders services for the
Class B Shares, the Distributor receives a distribution fee equal to 0.75% of
the Class B Shares' average daily net assets and a shareholder servicing fee
equal to 0.25% of the Class B Shares' average daily net assets. As compensation
for providing distribution and shareholder services for the Class C Shares, the
Distributor receives an aggregate distribution and shareholder servicing fee
equal to 0.75% of the Class C Shares' average daily net assets. As compensation
for providing distribution and shareholders service for the Class D Shares, the
Distributor receives an aggregate distribution and shareholder servicing fee
equal to 0.50% of the Class D Shares' average daily net assets. The shareholder
services component of the foregoing fees for Classes C and D is limited to 0.25%
of the average daily net assets of the respective class. As compensation for
providing distribution services for the Class E Shares, the Distributor receives
an aggregate distribution and shareholder servicing fee equal to 0.25% of the
average daily net assets of the Class E Shares. The Distributor may, in its
discretion, voluntarily waive from time to time all or any portion of its
distribution fee.
Payments under the Plans are made as described above regardless of the
Distributor's actual cost of providing distribution services and may be used to
pay the Distributor's overhead expenses. If the cost of providing distribution
services to the Fund is less than the payments received, the unexpended portion
of the distribution fees may be retained as profit by the Distributor. The
Distributor may from time to time and from its own resources pay or allow
additional discounts or promotional incentives in the form of cash or other
compensation (including merchandise or travel) to Financial Intermediaries and
it is free to make additional payments out of its own assets to promote the sale
of Fund shares. Similarly, the Advisor may, from its own resources, defray or
absorb costs related to distribution, including compensation of employees who
are involved in distribution.
37
<PAGE>
Class B, C, D and E shares were not offered prior to the end of the series'
respective fiscal year ends and therefore the Distributor received no
compensation from the series for such periods.
CUSTODIAN, INDEPENDENT ACCOUNTANTS, AND COUNSEL
The custodian for the Fund is Boston Safe Deposit and Trust Company, One
Cabot Road, 3rd Floor, Medford, MA 02155-5159. Boston Safe Deposit and Trust
Company may, at its own expense, employ one or more sub-custodians on behalf
of the Fund, provided that Boston Safe Deposit and Trust Company shall remain
liable for all its duties as custodian. The foreign sub-custodians will act
as custodian for the foreign securities held by the fund. Prior to
July 15, 1999, Deloitte & Touche LLP, 125 Summer Street, Boston, MA 02110
were the independent accountants for all the series except the PureMark-SM-
Series, which had not yet been activated. As of July 15, 1999, the board
has approved the appointment of PricewaterhouseCoopers LLP, 160 Federal
Street, Boston, MA 02110 as the independent accountants for all the series.
The Fund's counsel is Morgan, Lewis & Bockius LLP, 1701 Market Street,
Philadelphia, PA 19103.
PURCHASES AND REDEMPTIONS
Payment for shares redeemed. Payment for shares presented for redemption may
be delayed more than seven days only for (1) any period (A) during which the
New York Stock Exchange is closed other than customary weekend and holiday
closings or (b) during which trading on the New York Stock Exchange is
restricted; (2) for any period during which an emergency exists as a result
of which (a) disposal by the Fund of securities owned by it is not reasonably
practicable or (b) it is not reasonably practicable for the Fund to determine
the value of its net assets; or (3) for such other periods as the Securities
and Exchange Commission may by order permit.
Other Information about Purchases and Redemptions. The Fund has authorized
several brokers to accept purchase and redemption orders on its behalf, and
these brokers are authorized to designate other intermediaries to accept
purchase and redemption orders on the Fund's behalf. The Fund will be deemed to
have received a purchase or redemption order when an authorized broker or its
authorized designee accepts the order, and orders placed with an authorized
broker will be processed at the share price of the appropriate series next
computed after they are accepted by the authorized broker or its designee.
PORTFOLIO TRANSACTIONS AND BROKERAGE
The Agreement states that in connection with its duties to arrange for the
purchase and the sale of securities held in the portfolio of the Fund by placing
purchase and sale orders for the Fund, the Advisor shall select such
broker-dealers ("brokers") as shall, in the Advisor's judgment, implement the
policy of the Fund to achieve "best execution", i.e., prompt and efficient
execution at the most favorable securities price. In making such selection, the
Advisor is authorized in the Agreement to consider the reliability, integrity
and financial condition of the broker, the size and difficulty in executing the
order and the value of the expected contribution of the broker to the investment
performance of the Fund on a continuing basis. The Advisor is also authorized to
consider whether a broker provides brokerage and/or research services to the
Fund and/or other accounts of the Advisor. The Fund understands that a
substantial amount of its portfolio transactions may be transacted with primary
market makers acting as principal on a net basis, with
38
<PAGE>
no brokerage commissions being paid by the Fund. Such principal transactions
may, however, result in a profit to market makers. In certain instances the
Advisor may make purchases of underwritten issues for the Fund at prices which
include underwriting fees. The Agreement states that the commissions paid to
such brokers may be higher than another broker would have charged if a good
faith determination is made by the Advisor that the commission is reasonable in
relation to the services provided, viewed in terms of either that particular
transaction or the Advisor's overall responsibilities as to the accounts as to
which it exercises investment discretion and that the Advisor shall use its
judgment in determining that the amount of commissions paid are reasonable in
relation to the value of brokerage and research services provided. The Advisor
is further authorized to allocate the orders placed by it on behalf of the Fund
to such brokers or dealers who also provide research or statistical material, or
other services, to the Fund, the Advisor, or any affiliate of either. Such
allocation shall be in such amounts and proportions as the Advisor shall
determine, and the Advisor shall report on such allocations regularly to the
Fund, indicating the broker-dealers to whom such allocations have been made and
the basis therefore.
The research services discussed above may be in written form or through direct
contact with individuals and may include information as to particular companies
and securities as well as market economic or institutional areas and information
assisting the Fund in the valuation of its investments. The research which the
Advisor receives for the Fund's brokerage commissions, whether or not useful to
the Fund may be useful to the Advisor in managing the accounts of the Advisor's
other advisory clients. Similarly, the research received for the commissions of
such accounts may be useful to the Fund.
For years ended October 31, (unless otherwise indicated), the aggregate total
brokerage commissions paid by the series were as follows:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------
Series 1996 1997 1998
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Blended Asset Series I $13,656(1) $14,935 $36,215
- -------------------------------------------------------------------------------------------------------------
Blended Asset Series II $36,256(1) $48,030 $92,719
- -------------------------------------------------------------------------------------------------------------
Flexible Yield Series I $0 $0 $0
- -------------------------------------------------------------------------------------------------------------
Flexible Yield Series II $0 $0 $0
- -------------------------------------------------------------------------------------------------------------
Flexible Yield Series III $0 $0 $0
- -------------------------------------------------------------------------------------------------------------
Tax Managed $837(2) $883 $2,673
- -------------------------------------------------------------------------------------------------------------
Defensive $335(2) $570 $2,118
- -------------------------------------------------------------------------------------------------------------
Maximum Horizon $2,753(2) $20,570 $43,998
- --------------------------------------- ------------------------ ---------------------- ---------------------
</TABLE>
(1) For the period January 1, 1996 to October 31, 1996.
(2) For the period November 1, 1995 (Commencement of Operations) to October
31, 1996.
39
<PAGE>
There were no brokerage commissions paid to affiliates during the last three
fiscal years.
NET ASSET VALUE
The net asset value is determined on each day that the New York Stock Exchange
is open for trading. In determining the net asset value of the Fund's shares,
common stocks that are listed on national securities exchanges or the NASDAQ
National Market System are valued at the last sale price on the exchange on
which each stock is principally traded as of the close of the New York Stock
Exchange (generally 4:00 p.m., Eastern time), or, in the absence of recorded
sales, at the closing bid prices on such exchanges or on such System. Unlisted
securities that are not included in such National Market System are valued at
the quoted bid prices in the over-the-counter market. All securities initially
expressed in foreign currencies will be converted to U.S. dollars at the
exchange rates quoted at the close of the New York markets. Short securities
positions are accounted for at value, using the same method of valuation
described above. Securities and other assets for which market quotations are not
readily available are valued by appraisal at their fair value as determined in
good faith by the Advisor under procedures established by and under the general
supervision and responsibility of the Fund's Board of Directors. The Advisor may
use a pricing service to obtain the value of the Fund's portfolio securities
where the prices provided by such pricing service are believed to reflect the
fair market value of such securities. The methods used by the pricing service
and the valuations so established will be reviewed by the Advisor under the
general supervision of the Fund's Board of Directors. Several pricing services
are available, one or more of which may be used as approved by the Fund's Board
of Directors.
FEDERAL TAX TREATMENT OF DIVIDENDS AND DISTRIBUTIONS
The following is only a summary of certain tax considerations generally
affecting a series and its shareholders, and is not intended as a substitute for
careful tax planning. Shareholders are urged to consult their tax advisers with
specific reference to their own tax situations, including their state and local
tax liabilities.
The following discussion of certain federal income tax consequences is based on
the Code, and the regulations issued thereunder as in effect on the date of this
Statement of Additional Information. New legislation, certain administrative
changes, or court decisions may significantly change the conclusions expressed
herein, and may have a retroactive effect with respect to the transactions
contemplated herein.
It is the policy of each of the series to qualify for the favorable tax
treatment accorded regulated investment companies under Subchapter M of the
Code. By following such policy, each of the series expects to be relieved of
federal income tax on investment company taxable income and net capital gain
(the excess of net long-term capital gain over net short-term capital loss)
distributed to shareholders.
In order to qualify as a regulated investment company each series must, among
other things, (1) derive at least 90% of its gross income each taxable year from
dividends, interest, payments with respect to securities loans, gains
40
<PAGE>
from the sale or other disposition of stock, securities or foreign currencies,
or other income (including gains from options, futures or forward contracts)
derived with respect to its business of investing in stock, securities or
currencies; and (2) diversify its holdings so that at the end of each quarter of
each taxable year (i) at least 50% of the market value of the series' total
assets is represented by cash or cash items, U.S. government securities,
securities of other regulated investment companies, and other securities
limited, in respect of any one issuer, to a value not greater than 5% of the
value of the series' total assets and 10% of the outstanding voting securities
of such issuer, and (ii) not more than 25% of the value of its assets is
invested in the securities of any one issuer (other than U.S. government
securities or securities of any other regulated investment company) or of two or
more issuers that the series controls and that are engaged in the same, similar,
or related trades or businesses. These requirements may restrict the degree to
which the series may engage in certain hedging transactions and may limit the
range of the series' investments. If a series qualifies as a regulated
investment company, it will not be subject to federal income tax on the part of
its net investment income and net realized capital gains, if any, which it
distributes each year to the shareholders, provided the series distributes at
least (a) 90% of its "investment company taxable income" (generally, net
investment income plus the excess, if any, of net short-term capital gain over
net long-term capital loss) and (b) 90% of its net exempt interest income (the
excess of (i) its tax-exempt interest income over (ii) certain deductions
attributable to that income).
If for any taxable year, a series does not qualify as a regulated investment
company under Sub-chapter M of the Code, all of its taxable income will be
subject to tax at regular corporate tax rates without any deduction for
distributions to shareholders and all such distributions will be taxable to
shareholders as ordinary dividends to the extent of the series' current or
accumulated earnings and profits. Such distributions will generally qualify for
the corporate dividends received deduction for corporate shareholders.
If a series fails to distribute in a calendar year at least 98% of its ordinary
income for the year and 98% of its capital gain net income (the excess of short
and long term capital gains over short and long term capital losses) for the
one-year period ending October 31 of that year (and any retained amount from the
prior year), the series will be subject to a nondeductible 4% federal excise tax
on the undistributed amounts. The series generally intend to make sufficient
distributions to avoid imposition of this tax, except that, as described above,
the Tax Managed Series may choose to incur such tax if it anticipates that
retaining income will enhance its Shareholders' after-tax total returns.
Distributions declared in October, November, or December to shareholders of
record during those months and paid during the following January are treated as
if they were received by each shareholder on December 31 of the year in which
they are declared for tax purposes.
Any gain or loss recognized on a sale, exchange or redemption of shares of a
series by a shareholder who is not a dealer in securities will generally, for
individual shareholders, be treated as a long-term capital gain or loss if the
shares have been held for more than one year and otherwise generally will be
treated as short-term capital gain or loss. However, if shares on which a
41
<PAGE>
shareholder has received a net capital gain distribution are subsequently sold,
exchanged or redeemed and such shares have been held for six months or less, any
loss recognized will be treated as long-term capital loss to the extent of the
net capital gain distribution. Long-term capital gains generally are currently
taxed at a maximum rate of 20%, and short-term capital gains are currently taxed
at ordinary income tax rates.
In certain cases, a series will be required to withhold and remit to the U.S.
Treasury 31% of any taxable dividends, capital gain distributions and redemption
proceeds paid to a shareholder (1) who has failed to provide a correct and
properly certified taxpayer identification number, (2) who is subject to backup
withholding by the Internal Revenue Service, or (3) who has not certified to the
Fund that such shareholder is not subject to backup withholding. This backup
withholding is not an additional tax, and any amounts withheld may be credited
against the shareholder's U.S. federal income tax liability.
Dividends paid to nonresident alien individuals and foreign entities are
potentially subject to different tax treatment, including a possible U.S.
federal income tax, required to be withheld by the applicable series, at a 30%
rate (or a lower rate provided by an applicable income tax treaty).
Certification of foreign status by such shareholders also will generally be
required to avoid backup withholding on capital gain distributions and
redemption proceeds.
A series' transactions in certain futures contracts, options, forward contracts,
foreign currencies, foreign debt securities, foreign entities treated as
investment companies and certain other investment and hedging activities will be
subject to special tax rules. In a given case, these rules may accelerate income
to the series, defer losses to the series, cause adjustments in the holding
periods of the series' assets, convert short-term capital losses into long-term
capital losses, or otherwise affect the character of the series' income. These
rules could therefore affect the amount, timing, and character of distributions
to shareholders. Each series will endeavor to make any available elections
pertaining to such transactions in a manner believed to be in the best interest
of the series.
Shareholders will be advised annually as to the federal income tax consequences
of distributions made during the year. Certain distributions may qualify for a
dividends received deduction for corporate shareholders, subject to holding
period requirements and other limitations under the Code, if they are
attributable to the qualifying dividend income a series receives from a domestic
corporation and are properly designated by that Series. However, information set
forth in the Prospectuses and this Statement of Additional Information which
relates to taxation is only a summary of some of the important tax
considerations generally affecting purchasers of shares of the Fund's series. No
attempt has been made to present a detailed explanation of the tax treatment of
the Fund or its shareholders, and this discussion is not intended as a
substitute for careful tax planning. Accordingly, potential purchasers of shares
of a series are urged to consult their tax advisors with specific reference to
their own tax situation.
Distributions by the Fund to shareholders and the ownership of shares may be
subject to state and local taxes. Therefore, shareholders are urged to
42
<PAGE>
consult with their tax advisors concerning the application of state and local
taxes to investments in the Fund, which may differ from the federal income tax
consequences. For example, under certain specified circumstances, state income
tax laws may exempt from taxation distributions of a regulated investment
company to the extent that such distributions are derived from interest on
federal obligations. Shareholders are urged to consult with their tax advisors
regarding whether, and under what conditions, such exemption is available.
43
<PAGE>
PERFORMANCE INFORMATION
The Fund may from time to time quote various performance figures to illustrate
the Series' past performance.
Performance quotations by investment companies are subject to rules adopted by
the SEC, which require the use of standardized performance quotations. In the
case of total return, non-standardized performance quotations may be furnished
by the Fund but must be accompanied by certain standardized performance
information computed as required by the SEC. Current yield and average annual
compounded total return quotations used by the Fund are based on the
standardized methods of computing performance mandated by the SEC. An
explanation of those and other methods used by the Fund to compute or express
performance follows.
TOTAL RETURN
From time to time each Series may advertise total return for each class of
shares of the Series. Total return figures are based on historical earnings
and are not intended to indicate future performance. The average annual total
return is determined by finding the average annual compounded rates of return
over 1-, 5-, and 10-year periods (or over the life of the Series) that would
equate an initial hypothetical $1,000 investment to its ending redeemable value.
The calculation assumes that all dividends and distributions are reinvested when
paid. The quotation assumes the amount was completely redeemed at the end of
each 1-, 5-, and 10-year period (or over the life of the Series) and the
deduction of all applicable Fund expenses on an annual basis.
The average annual compounded rates of return (unless otherwise noted) for the
Fund's Series for the periods ended October 31, 1998 are as follows:
<TABLE>
<CAPTION>
Average
Average Annual
Inception One Annual Since
Name of Portfolio Date Year Five Years Inception
- ----------------- ---- ---- ---------- ---------
<S> <C> <C> <C> <C>
Blended Asset Series I 9/15/93 6.29% 8.92% 8.75%
Blended Asset Series II 10/12/93 -.56% 12.51% 12.26%
Flexible Yield Series I 2/15/94 7.57% -- 5.61%
Flexible Yield Series II 2/15/94 9.78% -- 6.39%
Flexible Yield Series III 12/20/93 12.15% -- 7.26%
Tax Managed Series 11/1/95 -2.34% -- 14.09%
Defensive Series 11/1/95 6.54% -- 6.72%
Maximum Horizon Series 11/1/95 -5.99% -- 11.13%
</TABLE>
44
<PAGE>
The PureMark-SM- Series was not active on October 31, 1998; therefore, no
performance information is shown.
The above figures were calculated according to the following formula:
P(1 +T)6= ERV
where:
P = a hypothetical initial payment of
$1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of
hypothetical $1,000 payment made at
the beginning of the l-, 5-, or 10-
year periods at the end of the l-,
5-, or 10-year periods (or
fractional portion thereof).
CALCULATION OF YIELD
From time to time certain of the Fund's Series may advertise yield.
Current yield reflects the income per share earned by a Series' investments.
Current yield is determined by dividing the net investment income per share
earned during a 30-day base period by the maximum offering price per share on
the last day of the period and annualizing the result. Expenses accrued for the
period include any fees charged to all shareholders during the base period.
The respective current yields for certain of the Series for the 30-day period
ended October 31, 1998 were as follows:
<TABLE>
<CAPTION>
Class A
Portfolio Name Shares
- -------------- ------
<S> <C>
Flexible Yield Series I 3.76%
Flexible Yield Series II 3.56%
Flexible Yield Series III 3.80%
</TABLE>
These figures were obtained using the following formula:
6
Yield = 2 [(a-b + 1) - 1]
---
Cd
FINANCIAL STATEMENTS
The financial statements of the Series are incorporated herein by reference
to the Series' 1998 Annual Reports to Shareholders. The financial statements
with respect to the Series have been audited by Deloitte & Touche LLP,
independent public accountants to such Series. Because the PureMark-SM-
Series was not active as of October 31, 1998, there are no financial
statements for that Series. A copy of the 1998 Annual Reports to Shareholders
must accompany the delivery of this Statement of Additional of Information.
45
<PAGE>
APPENDIX - DESCRIPTION OF BOND RATINGS(1)
MOODY'S INVESTORS SERVICE, INC. ("MOODY'S") SHORT-TERM PRIME RATING SYSTEM -
TAXABLE DEBT AND DEPOSITS GLOBALLY
Moody's short-term debt ratings are opinions of the ability of issuers to repay
punctually senior debt obligations. These obligations have an original maturity
not exceeding one year, unless explicitly noted.
Moody's employs the following three designations, all judged to be investment
grade, to indicate the relative repayment ability of rated issuers:
Prime-1: Issuers rated Prime-1 (or supporting institutions) have a superior
ability for repayment of senior short-term debt obligations. Prime-1 repayment
ability will often be evidenced by many of the following characteristics:
Leading market positions in well-established industries.
High rates of return on funds employed.
Conservative capitalization structure 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 rated Prime-2 (or supporting institutions) 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, may 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 rated Prime-3 (or supporting institutions) have an acceptable
ability for repayment of senior short-term obligations. The effect of industry
characteristics and market compositions 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 rated Not Prime do not fall within any of the Prime rating
categories.
Obligations of a branch of a bank are considered to be domiciled in the country
in which the branch is located. Unless noted as an exception, Moody's rating on
a bank's ability to repay senior obligations extends only to branches located in
countries which carry a Moody's Sovereign Rating for Bank
- ------------------------
(1) The ratings indicated herein are believed to be the most recent ratings
available at the date of this statement of additional information for the
securities listed. Ratings are generally given to securities at the time of
issuance. While the rating agencies may from time to time revise such ratings,
they undertake no obligation to do so, and the ratings indicated do not
necessarily represent ratings which will be given to these securities on the
date of the fund's fiscal year-end.
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<PAGE>
Deposits. Such branch obligations are rated at the lower of the bank's rating
or Moody's Sovereign Rating for Bank Deposits for the country in which the
branch is located.
When the currency in which an obligation is denominated is not the same as the
currency of the country in which the obligation is domiciled, Moody's ratings do
not incorporate an opinion as to whether payment of the obligation will be
affected by actions of the government controlling the currency of denomination.
In addition, risks associated with bilateral conflicts between an investor's
home country and either the issuer's home country or the country where an
issuer's branch is located are not incorporated into Moody's short-term debt
ratings.
If an issuer represents to Moody's that its short-term debt obligations are
supported by the credit of another entity or entities, then the name or names of
such supporting entity or entities are listed within the parenthesis beneath the
name of the issuer, or there is a footnote referring the reader to another page
for the name or names of the supporting entity or entities. In assigning ratings
to such issuers, Moody's evaluates the financial strength of the affiliated
corporations, commercial banks, insurance companies, foreign governments or
other entities, but only as one factor in the total rating assessment.
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
edge." Interest payments are protected by a large or by an exceptionally stable
margin and principal is secure. While the various protective elements are likely
to change, such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
Aa: Bonds which are rated Aa are judged to be of high quality by all standards.
Together with the Aaa group they comprise what are generally known as high grade
bonds. They are rated lower than the best bonds because margins of protection
may not be as large as in Aaa securities or fluctuation of protective elements
may be of greater amplitude or there may be other elements present which make
the long term risks appear somewhat larger than in Aaa securities.
A: Bonds which are rated A possess many favorable investment attributes and are
to be considered as upper-medium-grade obligations. Factors giving security to
principal and interest are considered adequate, but elements may be present
which suggest a susceptibility to impairment sometime in the future.
Baa: Bonds which are rated Baa are considered as medium-grade obligations (i.e.,
they are neither highly protected nor poorly secured). Interest payments and
principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
47
<PAGE>
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 indicated that the obligation
ranks in the higher end of its generic rating category; the modifier 2 indicated
a mid-range ranking; and the modifier 3 indicates a ranking in the lower end of
that generic rating category.
STANDARD & POOR'S SHORT-TERM ISSUE CREDIT RATINGS
A-1: A short-term obligation rated A-1 is rated in the highest category by
Standard & Poor's. 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
commitment on the obligation.
48
<PAGE>
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 Standard & Poor's 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.
STANDARD & POOR'S CORPORATE BOND RATINGS
Aaa: An obligation rated Aaa has the highest rating assigned by Standard &
Poor's. 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 a
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.
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 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.
49
<PAGE>
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 Standard & Poor's 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 are jeopardized.
Plus (+) or Minus (-): The rating from AA to CCC may be modified by the addition
of a plus or minus sign to show relative standing within the major 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.
