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Excelsior Biotechnology Fund
Prospectus
December 20, 2000
Excelsior Funds, Inc.
Investment Adviser
United States Trust Company of New York
U.S. Trust Company
The Securities and Exchange Commission has not approved or disapproved these
securities or passed upon the adequacy of this prospectus. Any representation
to the contrary is a criminal offense.
[LOGO OF EXCELSIOR FUNDS]
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Table of Contents
Excelsior Funds, Inc. is a mutual fund family that offers shares in separate
investment portfolios which have individual investment goals and strategies.
This prospectus gives you important information about the Biotechnology Fund
(the Fund) that you should know before investing. The Biotechnology Fund offers
one class of shares, called Shares. Please read this prospectus and keep it for
future reference.
This prospectus has been arranged into different sections so that you can eas-
ily review this important information. On the next page, there is some general
information you should know about the risk and returns of the Fund. For more
detailed information about the Fund, please see:
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Page
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Biotechnology Fund................................................... 1
More Information About Risk.......................................... 3
More Information About Fund Investments.............................. 3
Investment Adviser................................................... 3
Portfolio Managers................................................... 4
Purchasing, Selling and Exchanging Fund Shares....................... 4
Dividends and Distributions.......................................... 7
Taxes................................................................ 7
How to Obtain More Information About Excelsior Funds................. Back Cover
</TABLE>
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Biotechnology Fund
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FUND SUMMARY
Investment Goal Capital
appreciation
Investment Focus Common stocks
of biotechnology companies
Share Price Volatility High
Principal Investment
Strategy Invests in common
stocks of companies
principally engaged in the
research, development and
manufacture of various
biotechnological products,
services and processes
Investor Profile Investors
seeking capital appreciation,
and who are willing to accept
the risks of investing in a
portfolio of biotechnology
companies
Investment Objective
The Biotechnology Fund seeks superior, long-term capital appreciation.
Investment Strategy
The Fund seeks to achieve its objective by investing in companies principally
engaged in the research, development and manufacture of various
biotechnological products, services and processes, and whose long-term growth
prospects, in the Adviser's opinion, appear to exceed the overall market. For
example, the Fund may invest in companies involved with developments and appli-
cations in such areas as human health care, pharmaceuticals, agriculture, chem-
icals, medicine/surgery and industrial-oriented companies. In addition, invest-
ments may include securities of companies that: manufacture biotechnological
and biomedical products, including devices and instruments; provide
biotechnological processes or services; provide scientific and technological
advances in biotechnology; and develop new or experimental technologies, such
as genetic engineering. The Fund may also invest in securities of companies
that distribute biotechnological and biomedical products, including devices and
instruments, and companies that benefit significantly from scientific and tech-
nological advances in biotechnology.
Under normal market conditions, the Biotechnology Fund invests at least 65% of
its assets in the equity securities of U.S., and to a lesser extent, foreign
biotechnology companies. The Fund may invest in companies of any size, includ-
ing small, high-growth companies and medium size companies.
In selecting investments for the Fund, the Adviser takes a long-term approach
and seeks to identify biotechnology companies whose value is not recognized in
the prices of their securities or with characteristics that will lead to above-
average earnings growth.
Principal Risks of Investing in the Fund
Biotechnology companies are often small, start-up ventures whose products are
only in the research stage. Only a limited number of biotechnology companies
have reached the point of approval of products by the FDA and subsequent com-
mercial production and distribution of such products. Therefore, the success of
investments in the biotechnology industry is often based on speculation and ex-
pectations about future products, research progress and new product filings
with regulatory authorities. Such investments are speculative and may drop
sharply in value in response to regulatory or research setbacks.
The Fund is subject to the risk that the securities of issuers engaged in the
biotechnology sector of the economy that the Fund purchases will underperform
other market sectors or the market as a whole. To the extent that the Fund's
investments are concentrated in issuers conducting business in the biotechnol-
ogy sector, the Fund is subject to adverse market conditions, patent considera-
tions, intense competition and/or rapid technological change and obsolescence
affecting that sector. The biotechnology sector also is subject to extensive
government regulatory requirements, regulatory approval for new drugs and medi-
cal products, product liability and similar matters. As these factors impact
the biotechnology sector, the value of securities of biotechnology companies
may experience dramatic price movements that have little or no basis in funda-
mental economic conditions. In addition, biotechnology companies can have per-
sistent losses during a new product's transition from development to produc-
tion, and revenue patterns can be erratic. As a result, the Fund's investment
in biotechnology companies may subject it to more volatile price movements than
as investment in a more diversified securities portfolio.
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Since it purchases equity securities, the Fund is subject to the risk that
stock prices will fall over short or extended periods of time. Historically,
the equity markets have moved in cycles, and the value of the Fund's equity se-
curities may fluctuate substantially from day to day. Individual companies may
report poor results or be negatively affected by industry and/or economic
trends and developments. The prices of securities issued by such companies may
suffer a decline in response. These factors contribute to price volatility,
which is the principal risk of investing in the Fund.
The Fund also may be subject to risks particular to its investments in foreign,
medium and smaller capitalization companies. These stocks may be more volatile
than other equity securities, and the risks associated with them are discussed
in greater detail in the section entitled "More Information About Risk."
As with any investment, the loss of money is a risk of investing in the Fund.
An investment in the Fund is not a deposit in United States Trust Company of
New York or U.S. Trust Company and is not insured or guaranteed by the Federal
Deposit Insurance Company or any other government agency.
Performance Information
There is no performance information for the Biotechnology Fund because the Fund
had not yet commenced operations as of the date of this prospectus.
Fund Fees and Expenses
This table describes the fees and expenses that you may pay if you buy and hold
shares of the Fund.
Annual Fund Operating Expenses
(expenses that are deducted from Fund assets)
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Management Fees 1.00%
Other Expenses
Administrative Servicing Fee 0.40%
Other Operating Expenses 0.25%
Total Other Expenses 0.65%
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Total Annual Fund Operating Expenses 1.65%*
Fee Waiver 0.40%
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Net Annual Fund Operating Expenses 1.25%*
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* The Fund's total annual fund operating expenses and net annual fund operating
expenses are estimated based on expenses expected to be incurred in the cur-
rent fiscal year. The Adviser has contractually agreed, for the period com-
mencing on the date of this prospectus and ending March 31, 2002, to keep to-
tal annual fund operating expenses from exceeding 1.25%.
Example
This Example is intended to help you compare the cost of investing in the Fund
with the cost of investing in other mutual funds. The Example assumes that you
invest $10,000 in the Fund for the time periods indicated and that you sell
your shares at the end of the period.
The Example also assumes that each year your investment has a 5% return, Fund
operating expenses remain the same and you reinvest all dividends and distribu-
tions. Although your actual costs and returns might be different, your approxi-
mate costs of investing $10,000 in the Fund would be:
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1 Year 3 Years
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$127 $397
</TABLE>
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More Information About Risk
Equity Risk
Equity securities include public and privately issued equity securities, common
and preferred stocks, warrants, rights to subscribe to common stock and con-
vertible securities, as well as instruments that attempt to track the price
movement of equity indices. Investments in these types of equity securities in
general are subject to market risks that may cause their prices to fluctuate
over time. The value of securities convertible into equity securities, such as
warrants or convertible debt, is also affected by prevailing interest rates,
the credit quality of the issuer and any call provision.
Small Cap Risk
The smaller capitalization companies in which the Fund may invest, which gener-
ally have market capitalizations up to $1.5 billion, may be more vulnerable to
adverse business or economic events than larger, more established companies. In
particular, these small companies may have limited product lines, markets and
financial resources, and may depend upon a relatively small management group.
Therefore, small cap stocks may be more volatile than those of larger compa-
nies.
Mid Cap Risk
The medium capitalization companies in which the Fund may invest, which gener-
ally have market capitalizations between $1.5 billion and $5 billion, may be
more vulnerable to adverse business or economic events than larger companies.
In particular, these companies may have limited product lines, markets and fi-
nancial resources, and may depend on a relatively small management group.
Therefore, medium capitalization stocks may be more volatile than those of
larger companies.
Foreign Security Risks
Investments in securities of foreign companies or governments can be more vola-
tile than investments in U.S. companies or the U.S. government. Diplomatic, po-
litical, or economic developments, including nationalization or appropriation,
could affect investments in foreign countries. Foreign securities markets gen-
erally have less trading volume and less liquidity than U.S. markets. In addi-
tion, the value of securities denominated in foreign currencies, and of divi-
dends from such securities, can change significantly when foreign currencies
strengthen or weaken relative to the U.S. dollar. Foreign companies or govern-
ments generally are not subject to uniform accounting, auditing, and financial
reporting standards comparable to those applicable to domestic U.S. companies
or the U.S. government. Transaction costs are generally higher than those in
the U.S. and expenses for custodial arrangements of foreign securities may be
somewhat greater than typical expenses for custodial arrangements of similar
U.S. securities.
Some foreign governments levy withholding taxes against dividend and interest
income. Although in some countries a portion of these taxes is recoverable, the
non-recovered portion will reduce the income received from the securities com-
prising the portfolio.
Currency Risk
Investments in foreign securities denominated in foreign currencies involve ad-
ditional risks, including:
. The Fund may incur substantial costs in connection with conversions between
various currencies.
. Only a limited market currently exists for hedging transactions relating to
currencies in certain emerging markets.
More Information About Fund Investments
In addition to the investments and strategies described in this prospectus, the
Fund also may invest in other securities, use other strategies and engage in
other investment practices. These investments and strategies, as well as those
described in this prospectus, are described in detail in our Statement of Addi-
tional Information.
The investments and strategies described in this prospectus are those that we
use under normal conditions. During adverse economic, market or other condi-
tions, the Fund may take temporary defensive positions such as investing up to
100% of its assets in investments that would not ordinarily be consistent with
the Fund's objective. The Fund may not achieve its objective when so invested.
The Fund will do so only if the Adviser believes that the risk of loss out-
weighs the opportunity for capital gains or higher income. Of course, the Fund
cannot guarantee that it will achieve its investment goal.
Investment Adviser
United States Trust Company of New York and U.S. Trust Company (together, U.S.
Trust or the Adviser) serve as investment adviser to the Fund. United States
Trust Company of New York is a state-chartered bank and trust company and a
member bank of the Federal Reserve System. U.S. Trust Company is a Connecticut
state bank and trust company. Each is a wholly-owned
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subsidiary of U.S. Trust Corporation, a registered bank holding company.
U. S. Trust Corporation is a wholly-owned subsidiary of The Charles Schwab Cor-
poration ("Schwab"). Charles R. Schwab is the founder, Chairman, Co-Chief Exec-
utive Officer and a Director and significant shareholder of Schwab. As a result
of his positions and share ownership, Mr. Schwab may be deemed to be a control-
ling person of Schwab and its subsidiaries. Through its principal subsidiary
Charles Schwab & Co., Inc., Schwab is one of the nation's largest financial
services firms and the nation's largest electronic brokerage firm, in each case
measured by customer assets. At December 31, 1999, Schwab served 6.6 million
active accounts with $725 billion in customer assets.
U.S. Trust is one of the oldest investment management companies in the country.
Since 1853, U.S. Trust has been a leader in wealth management for sophisticated
investors providing trust and banking services to individuals, corporations and
institutions, both nationally and internationally, including investment manage-
ment, estate and trust administration, financial planning, corporate trust and
agency banking, and personal and corporate banking. On December 31, 1999, U.S.
Trust had approximately $86 billion in aggregate assets under management.
United States Trust Company of New York has its principal offices at 114 W.
47th Street, New York, NY 10036. U.S. Trust Company has its principal offices
at 225 High Ridge Road, Stamford, CT 06905.
The Adviser makes investment decisions for the Fund and continuously reviews,
supervises and administers the Fund's investment program.
U.S. Trust is entitled to receive advisory fees, as a percentage of daily net
assets, at the rate of 1.00%. U.S. Trust has contractually agreed to waive fees
and reimburse expenses of the Fund to the extent necessary to keep total Fund
operating expenses at 1.25% of the Fund's average daily net assets for the pe-
riod commencing on the date of this prospectus and ending March 31, 2002.
U.S. Trust and its affiliates advise and manage assets for their private cli-
ents and funds, some of which have investment objectives and policies similar
to Excelsior Funds. U.S. Trust and its affiliates will not have any obligation
to make available or use any information regarding these proprietary investment
activities for the benefit of the Funds. The research department of U.S. Trust
prepares research reports that are utilized by these Funds, wealth managers of
U.S. Trust and Schwab and its affiliates. It is U.S. Trust's intention to dis-
tribute this information as simultaneously as possible to all recipients. How-
ever, where the investment manager of an Excelsior Fund prepares such research,
that Fund may and often does receive and act upon that information before it is
disseminated to other parties, which in turn may have a negative effect on the
price of the security subject to research.
The Board of Directors of Excelsior Funds, Inc. supervises the Adviser and es-
tablishes policies that the Adviser must follow in its management activities.
Portfolio Managers
Maria L. Brisbane, CFA, and John F. Lafferty, CFA, serve as the Fund's portfo-
lio co-managers. Ms. Brisbane, a Senior Vice President and Senior Portfolio
Manager of the Personal Investment Division of U.S. Trust, has been with U.S.
Trust since 1994. Mr. Lafferty, a Senior Vice President and healthcare industry
analyst in U.S. Trust's Equity Research Division, has been with U.S. Trust
since 1998. Prior to joining U.S. Trust, Mr. Lafferty was a Vice President and
healthcare industry analyst with J.P. Morgan & Co. Ms. Brisbane and Mr. Laf-
ferty are primarily responsible for the day-to-day management of the Fund's
portfolio. Research, analyses, trade execution and other facilities provided by
U.S. Trust and other personnel also play a significant role in portfolio man-
agement and performance.
Purchasing, Selling and Exchanging Fund Shares
This section tells you how to purchase, sell (sometimes called "redeem") or ex-
change shares of the Fund.
How to Purchase Fund Shares
You may purchase shares directly by:
. Mail
.Telephone
.Wire, or
.Automatic Investment Program
To purchase shares directly from us, please call (800) 446-1012 (from overseas,
call (617) 557-8280), or complete and send in the enclosed application to Ex-
celsior Funds, c/o Chase Global Funds Services Company, P.O. Box 2798, Boston,
MA 02208-2798. Unless you arrange
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to pay by wire or through the automatic investment program, write your check,
payable in U.S. dollars, to "Excelsior Funds" and include the name of the Fund
on the check. The Fund cannot accept third-party checks, credit cards, credit
card checks or cash. To purchase shares by wire, please call us for instruc-
tions. Federal funds and registration instructions should be wired through the
Federal Reserve System to:
The Chase Manhattan Bank
ABA #021000021
Excelsior Funds, Account Number 9102732915
For Further Credit To:
Excelsior Funds
Wire Control Number
Excelsior Funds Account Registration
(including account number)
Investors making initial investments by wire must promptly complete the en-
closed application and forward it to the address indicated on the application.
Investors making subsequent investments by wire should follow the above in-
structions.
You may also buy shares through accounts with brokers and other institutions
that are authorized to place trades in Fund shares for their customers. If you
invest through an authorized institution, you will have to follow its proce-
dures, which may be different from the procedures for investing directly. Your
broker or institution may charge a fee for its services, in addition to the
fees charged by the Fund. You will also generally have to address your corre-
spondence or questions regarding a Fund to your institution.
The Fund's distributor may institute promotional incentive programs for deal-
ers, which will be paid for by the distributor out of its own assets and not
out of the assets of the Fund. Subject to NASD regulation, compensation may in-
clude promotional and other merchandise, sales and training programs and other
special events sponsored by dealers. Compensation may also include payment for
reasonable expenses incurred in connection with trips taken by invited regis-
tered representatives for meetings or seminars of a business nature.
General Information
You may purchase shares on any day that the New York Stock Exchange (NYSE) and
the Adviser are open for business (a "Business Day"). Presently, the only Busi-
ness Days on which the Adviser is closed and the NYSE is open are Veterans' Day
and Columbus Day. The Fund may reject any purchase request if it is determined
that accepting the request would not be in the best interests of the Fund or
its shareholders.
The price per share (the offering price) will be the net asset value per share
(NAV) next determined after the Fund receives your purchase request in good or-
der. We consider requests to be in "good order" when all required documents are
properly completed, signed and received.
The Fund calculates its NAV once each Business Day at the regularly-scheduled
close of normal trading on the NYSE (normally, 4:00 p.m., Eastern time). So,
for you to receive the current Business Day's NAV, the Fund must receive your
purchase request in good order before 4:00 p.m., Eastern time.
How We Calculate NAV
NAV for one Fund share is the value of that share's portion of all of the
Fund's assets less all of the Fund's liabilities.
In calculating NAV, the Fund generally values its investment portfolio at mar-
ket price. If market prices are unavailable or the Adviser thinks that they are
unreliable, fair value prices may be determined in good faith using methods ap-
proved by the Board of Directors. Fixed income investments with remaining matu-
rities of 60 days or less generally are valued at their amortized cost which
approximates their market value.
The Fund may hold securities that are listed on foreign exchanges. These secu-
rities may trade on weekends or other days when the Fund does not calculate
NAV. As a result, the market value of a Fund's investments may change on days
when you cannot purchase or sell Fund shares.
Minimum Purchases
To purchase shares for the first time, you must invest at least $500 ($250 for
IRAs) in the Fund.
Your subsequent investments must be made in amounts of at least $50.
The Fund may accept investments of smaller amounts at its discretion.
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Automatic Investment Program
If you have a checking, money market or NOW account with a bank, you may pur-
chase shares automatically through regular deductions from your account in
amounts of at least $50 per transaction.
With a $50 minimum initial investment, you may begin regularly scheduled in-
vestments once per month, on either the first or fifteenth day, or twice per
month, on both days.
How to Sell Your Fund Shares
You may sell shares directly by:
. Mail
.Telephone, or
.Systematic Withdrawal Plan
Holders of Fund shares may sell (sometimes called "redeem") shares by following
procedures established when they opened their account or accounts. If you have
questions, call (800) 446-1012 (from overseas, call (617) 557-8280).
You may sell your shares by sending a written request for redemption to:
Excelsior Funds
c/o Chase Global Funds Services Company
P.O. Box 2798
Boston, MA 02208-2798
Please be sure to indicate the number of shares to be sold, identify your ac-
count number and sign the request.
If you own your shares directly and previously indicated on your account appli-
cation or arranged in writing to do so, you may sell your shares on any Busi-
ness Day by contacting the Fund directly by telephone at (800) 446-1012 (from
overseas, call (617) 557-8280). The minimum amount for telephone redemptions is
$500. Shares will not be redeemed by the Fund unless all required documents
have been received by the Funds. Shares will not be redeemed by the Fund unless
all required documents have been received by the Fund.
If you own your shares through an account with a broker or other institution,
contact that broker or institution to sell your shares. Your broker or institu-
tion may charge a fee for its services, in addition to the fees charged by the
Fund.
If you would like to sell $50,000 or more of your shares, or any amount if the
proceeds are to be sent to an address other than the address of record, please
notify the Fund in writing and include a signature guarantee by a bank or other
financial institution (a notarized signature is not sufficient).
The sale price of each share will be the next NAV determined after the Fund re-
ceives your request in good order.
Systematic Withdrawal Plan
If you have at least $10,000 in your account, you may use the systematic with-
drawal plan. Under the plan you may arrange monthly, quarterly, semi-annual or
annual automatic withdrawals from the Fund. The proceeds of each withdrawal
will be mailed to you by check or, if you have a checking or savings account
with a bank, electronically transferred to your account.
Receiving Your Money
Normally, we will send your sale proceeds within five Business Days after we
receive your request in good order. Your proceeds can be wired to your bank ac-
count (if more than $500) or sent to you by check. If you recently purchased
your shares by check, redemption proceeds may not be available until your check
has cleared (which may take up to 15 Business Days from your date of purchase).
Redemptions in Kind
We generally pay sale (redemption) proceeds in cash. However, under unusual
conditions that make the payment of cash unwise, we might pay all or part of
your redemption proceeds in liquid securities with a market value equal to the
redemption price (redemption in kind). It is highly unlikely that your shares
would ever be redeemed in kind, but if they were you would probably have to pay
transaction costs to sell the securities distributed to you, as well as taxes
on any capital gains from the sale as with any redemption.
Involuntary Sales of Your Shares
If your account balance drops below $500 because of redemptions, you may be re-
quired to sell your shares. But, we will always give you at least 60 days'
written notice to give you time to add to your account and avoid the sale of
your shares.
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Suspension of Your Right to Sell Your Shares
The Fund may suspend your right to sell your shares if the NYSE restricts trad-
ing, the SEC declares an emergency or when U.S. Trust and the custodian are
closed. More information about this is in our Statement of Additional Informa-
tion.
How to Exchange Your Shares
You may exchange your shares on any Business Day for shares of any portfolio of
Excelsior Funds, Inc. or Excelsior Tax-Exempt Funds, Inc., or for shares of
certain portfolios of Excelsior Institutional Trust. In order to protect other
shareholders, we may limit your exchanges to no more than six per year or re-
ject an exchange if we deem the exchange would not be in the best interests of
the Fund or its shareholders. This limitation is not intended to limit a share-
holder's right to redeem shares of the Fund. Rather, the limitation is intended
to curb short-term trading. Shares can be exchanged directly by mail, or by
telephone if you previously selected the telephone exchange option on the ac-
count application.
You may also exchange shares through your financial institution. Exchange re-
quests must be for an amount of at least $500.
If you recently purchased shares by check you may not be able to exchange your
shares until your check has cleared (which may take up to 15 Business Days from
your date of purchase). This exchange privilege may be changed or canceled at
any time upon 60 days' notice.
When you exchange shares, you are really selling your shares and buying other
Fund shares. So, your sale price and purchase price will be based on the NAV
next calculated after the Fund receives your exchange request in good order.
Telephone Transactions
Purchasing, selling and exchanging Fund shares over the telephone is extremely
convenient, but not without risk. Although the Fund has certain safeguards and
procedures to confirm the identity of callers and the authenticity of instruc-
tions, the Fund is not liable for any losses or costs incurred by following
telephone instructions it reasonably believes to be genuine, provided that the
Fund follows its telephone transactions procedures. If you or your financial
institution transact with a Fund over the telephone, you will generally bear
the risk of any loss.
Authorized Intermediaries
Certain intermediaries, such as brokers or other shareholder organizations, are
authorized to accept purchase, redemption and exchange requests for Fund
shares. These intermediaries may authorize other organizations to accept pur-
chase, redemption and exchange requests for Fund shares. These requests are
normally executed at the NAV next determined after the intermediary receives
the request in good order. Authorized intermediaries are responsible for trans-
mitting requests and delivering funds on a timely basis.
Shareholder Servicing
The Fund is permitted to pay an administrative shareholder servicing fee to
certain shareholder organizations for providing services to their customers who
hold shares of the Fund. These services may include assisting in the processing
of purchase, redemption and exchange requests and providing periodic account
statements. The shareholder servicing fee may be up to 0.40% of the average
daily net asset value of Fund shares held by clients of a shareholder organiza-
tion.
Dividends and Distributions
The Fund distributes dividends from its income quarterly.
The Fund makes distributions of capital gains, if any, at least annually. If
you own Fund shares on the Fund's record date, you will be entitled to receive
the distribution.
Dividends and distributions for shares held of record by U.S. Trust and its af-
filiates or correspondent banks will be paid in cash. Otherwise, dividends and
distributions will be paid in the form of additional Fund shares unless you
elect to receive payment in cash. To elect cash payment, you must notify the
Fund in writing prior to the date of the distribution. Your election will be
effective for dividends and distributions paid after the Fund receives your
written notice. To cancel your election, simply send the Fund written notice.
Taxes
The Fund will distribute substantially all of its taxable income including its
net capital gain (the excess of long-term capital gain over short-term capital
loss), if any. Distributions you receive from the Fund will generally be tax-
able regardless of whether they are paid in cash or reinvested in additional
shares. Distributions
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attributable to the net capital gain of the Fund will be taxable to you as
long-term capital gain, regardless of how long you have held your shares. Other
Fund distributions will generally be taxable as ordinary income.
You should note that if you purchase shares just before a distribution, the
purchase price will reflect the amount of the upcoming distribution, but you
will be taxed on the entire amount of the distribution received, even though,
as an economic matter, the distribution simply constitutes a return of capital.
This is known as "buying into a dividend."
You will recognize taxable gain or loss on a sale, exchange or redemption of
your shares, including an exchange for shares of another Fund, based on the
difference between your tax basis in the shares and the amount you receive for
them. To aid in computing your tax basis, you generally should retain your ac-
count statements for the periods during which you held shares.
Any loss realized on shares held for six months or less will be treated as a
long-term capital loss to the extent of any capital gain dividends that were
received on the shares.
The one major exception to these tax principles is that distributions on, and
sales, exchanges and redemptions of, shares held in an IRA (or other tax-quali-
fied plan) will generally not be currently taxable.
Shareholders may also be subject to state and local taxes on distributions and
redemptions. State income taxes may not apply however, to the portions of each
Fund's distributions, if any, that are attributable to interest on federal se-
curities or interest on securities of the particular state or localities within
the state.
The foregoing is only a summary of certain tax considerations under current
law, which may be subject to change in the future. Shareholders who are nonres-
ident aliens, foreign trusts or estates, or foreign corporations or partner-
ships, may be subject to different United States federal income tax treatment.
You should consult your tax adviser for further information regarding federal,
state, local and/or foreign tax consequences relevant to your specific situa-
tion.
More information about taxes is in the Statement of Additional Information.
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Excelsior Funds, Inc.
Investment Adviser
United States Trust Company of New York
114 W. 47th Street
New York, New York 10036
U.S. Trust Company
225 High Ridge Road
Stamford, Connecticut 06905
Distributor
Edgewood Services, Inc.
5800 Corporate Drive
Pittsburgh, Pennsylvania 15237-5829
More information about the Fund is available without charge through the follow-
ing:
Statement of Additional Information (SAI)
The SAI, dated December 20, 2000, includes detailed information about Excelsior
Funds, Inc. The SAI is on file with the SEC and is incorporated by reference
into this prospectus. This means that the SAI, for legal purposes, is a part of
this prospectus.
Annual and Semi-Annual Reports
These reports contain additional information about the Fund's investments. The
Annual Report also lists the Fund's holdings and contains information from the
Fund's managers about strategies, and recent market conditions and trends and
their impact on Fund performance.
To Obtain an SAI, Annual or Semi-Annual Report, or More Information:
By Telephone: Call (800) 466-1012 (from overseas, call (617) 557-8280)
By Mail: Excelsior Funds, Inc., 73 Tremont Street, Boston, Massachusetts 02108-
3913
By Internet: http://www.excelsiorfunds.com
From the SEC: You can also obtain the SAI or the Annual and Semi-Annual re-
ports, as well as other information about Excelsior Funds, Inc., from the EDGAR
Database on the SEC's website ("http://www.sec.gov"). You may review and copy
documents at the SEC Public Reference Room in Washington, DC (for information
on the operation of the Public Reference Room call 202-942-8090). You may re-
quest documents by mail from the SEC, upon payment of a duplicating fee, by
writing to: Securities and Exchange Commission, Public Reference Section, Wash-
ington, DC 20549-0102. You may also obtain this information, upon payment of a
duplicating fee, by e-mailing the SEC at the following address:
[email protected]. Excelsior Funds, Inc.'s Investment Company Act registration
number is 811-4088.
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EXCELSIOR FUNDS, INC.
Biotechnology Fund
STATEMENT OF ADDITIONAL INFORMATION
December 20, 2000
This Statement of Additional Information is not a prospectus but should be read
in conjunction with the current prospectus for the Biotechnology Fund (the
"Fund") of Excelsior Funds, Inc. ("the Company") dated December 20, 2000 (the
"Prospectus"). A copy of the Prospectus may be obtained by writing the Company
c/o Chase Global Funds Services Company, 73 Tremont Street, Boston, MA
02108-3913 or by calling (800) 446-1012. Capitalized terms not otherwise defined
have the same meaning as in the Prospectus.
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TABLE OF CONTENTS Page
CLASSIFICATION AND HISTORY...................................................2
INVESTMENT OBJECTIVE, STRATEGIES AND RISKS...................................2
Investment Philosophy and Strategies................................2
Additional Investment Policies......................................3
Additional Information on Portfolio Instruments.....................4
INVESTMENT LIMITATIONS......................................................15
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION..............................17
Purchase of Shares.................................................18
Redemption Procedures..............................................19
Other Redemption Information.......................................20
INVESTOR PROGRAMS...........................................................20
Systematic Withdrawal Plan.........................................20
Exchange Privilege.................................................21
Retirement Plans...................................................22
Automatic Investment Program.......................................22
Additional Information.............................................23
DESCRIPTION OF CAPITAL STOCK................................................23
MANAGEMENT OF THE FUND......................................................25
Directors and Officers.............................................25
Investment Advisory and Administration Agreements..................30
Shareholder Organizations..........................................32
Personal Trading...................................................32
Expenses...........................................................33
Custodian and Transfer Agent.......................................33
PORTFOLIO TRANSACTIONS......................................................34
PORTFOLIO VALUATION.........................................................36
INDEPENDENT AUDITORS........................................................38
COUNSEL.....................................................................38
ADDITIONAL INFORMATION CONCERNING TAXES.....................................38
PERFORMANCE INFORMATION.....................................................39
MISCELLANEOUS...............................................................42
APPENDIX A.................................................................A-1
APPENDIX B.................................................................B-1
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CLASSIFICATION AND HISTORY
--------------------------
Excelsior Funds, Inc. (the "Company") is an open-end management investment
company. The Fund is a separate series of the Company and is classified as
diversified under the Investment Company Act of 1940, as amended (the "1940
Act"). The Company was organized as a Maryland corporation on August 2, 1984.
Prior to December 28, 1995, the Company was known as "UST Master Funds, Inc."
INVESTMENT OBJECTIVE, STRATEGIES AND RISKS
------------------------------------------
The following information supplements the description of the investment
objective, strategies and risks of the Fund as set forth in the Prospectus. The
investment objective of the Fund may not be changed without the vote of the
holders of a majority of its outstanding shares (as defined below). Except as
expressly noted below, the Fund's investment policies may be changed without
shareholder approval.
Investment Philosophy and Strategies
------------------------------------
The Fund will invest in companies principally engaged in the research
development and manufacture of various biotechnological products, services and
processes.
General Information About the Fund. The Fund is a mutual fund. A mutual
fund pools shareholders' money and, using professional investment managers,
invests it in securities.
The Fund has its own investment goal, strategies and risks for reaching
that goal. The investment managers invest Fund assets in a way that they believe
will help the Fund achieve its goal. Still, investing in the Fund involves risk
and there is no guarantee that the Fund will achieve its goal. An investment
manager's judgments about the markets, the economy, or companies may not
anticipate actual market movements, economic conditions or company performance,
and these judgments may affect the return on your investment. In fact, no matter
how good a job an investment manager does, you could lose money on your
investment in the Fund, just as you could with other investments. A Fund share
is not a bank deposit and is not insured or guaranteed by the FDIC or any
government agency.
The value of your investment in the Fund is based on the market value of
the securities the Fund holds. These prices change daily due to economic and
other events that affect particular companies and other issuers. These price
movements, sometimes called volatility, may be greater or lesser depending on
the types of securities the Fund owns and the markets in which they trade. The
effect on the Fund of a change in the value of a single security will depend on
how widely the Fund diversifies its holdings.
The Adviser's Equity Investment Philosophy. The Adviser manages the Fund's
investments with a view toward long-term success. To achieve this success, the
Adviser utilizes two fundamental investment strategies, value and growth. These
strategies are combined with
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"longer-term investment themes" to assess the investment potential of individual
companies. Specific investment selection is a "bottom-up" approach, guided by
these strategies and themes to ensure proper diversification, risk control and
market focus.
Value. This long-term strategy consists of searching for, identifying and
-----
obtaining the benefits of present or future investment values. For example, such
values may be found in a company's future earnings potential or in its existing
resources and assets. Accordingly, the Adviser is constantly engaged in
assessing, comparing and judging the worth of companies, particularly in
comparison to the price the markets place on such companies' shares.
Growth. This long-term strategy consists of buying and holding equity
------
securities of companies which it believes to be of high quality and high growth
potential. Typically, these companies are industry leaders with the potential to
dominate their markets by being low-cost, high-quality producers of products or
services. Usually these companies have an identifiable competitive advantage.
The Adviser believes that the earnings growth rate of these companies is the
primary determinant of their stock prices and that efficient markets will reward
consistently above average earnings growth with greater-than-average capital
appreciation over the long-term.
Themes. To complete the Adviser's investment philosophy in managing the
------
Fund, the investment strategies discussed above are applied in concert with
long-term investment themes to identify investment opportunities. These
longer-term themes are strong and inexorable trends arising from time to time
from economic, social, demographic and cultural forces. The Adviser also
believes that understanding the instigation, catalysts and effects of these
long-term trends will enable it to identify companies that are currently or will
soon benefit from these trends.
Additional Investment Policies
------------------------------
Under normal market and economic conditions, the Fund will invest at least
65% of its total assets in equity securities of biotechnology companies.
Biotechnology companies are those companies principally engaged in the research,
development and manufacture of various biotechnological products, services and
processes. Normally, up to 35% of the Fund's total assets may be invested in
other securities and instruments including, e.g., investment-grade debt
securities (i.e., debt obligations classified within the four highest ratings of
a nationally recognized statistical rating organization such as Moody's
Investors Service, Inc. ("Moody's") or Standard & Poor's Ratings Services
("S&P") or, if unrated, determined by the Adviser to be of comparable quality),
warrants, options and futures instruments as described in more detail below.
During temporary defensive periods or when the Adviser believes that suitable
investments are unavailable, the Fund may hold cash and/or invest some or all of
its assets in U.S. government securities, high-quality money market instruments
and repurchase agreements collateralized by the foregoing obligations.
Portfolio holdings will include equity securities of companies having
capitalizations of varying amounts, and the Fund may invest in the securities of
high growth, small companies when the Adviser expects earnings and the price of
the securities to grow at an
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above-average rate. Certain securities owned by the Fund may be traded only in
the over-the-counter market or on a regional securities exchange, may be listed
only in the quotation service commonly known as the "pink sheets," and may not
be traded every day or in the volume typical of trading on a national securities
exchange. As a result, there may be a greater fluctuation in the value of the
Fund's shares, and the Fund may be required, in order to satisfy redemption
requests or for other reasons, to sell these securities at a discount from
market prices, to sell during periods when such disposition is not desirable, or
to make many small sales over a period of time.
The Fund may invest in the securities of foreign issuers directly or
indirectly through sponsored and unsponsored American Depository Receipts
("ADRs"). ADRs represent receipts typically issued by a U.S. bank or trust
company which evidence ownership of underlying securities of foreign issuers.
Investments in unsponsored ADRs involve additional risk because financial
information based on generally accepted accounting principles ("GAAP") may not
be available for the foreign issuers of the underlying securities. ADRs may not
necessarily be denominated in the same currency as the underlying securities
into which they may be converted. The Fund may also enter into foreign currency
exchange transactions for hedging purposes.
Additional Information on Portfolio Instruments
-----------------------------------------------
Borrowing and Reverse Repurchase Agreements
-------------------------------------------
The Fund may borrow funds, in an amount up to 10% of the value of its total
assets, for temporary or emergency purposes, such as meeting larger than
anticipated redemption requests, and not for leverage. The Fund may also agree
to sell portfolio securities to financial institutions such as banks and
broker-dealers and to repurchase them at a mutually agreed date and price (a
"reverse repurchase agreement"). The SEC views reverse repurchase agreements as
a form of borrowing. At the time the Fund enters into a reverse repurchase
agreement, it will place in a segregated custodial account liquid assets having
a value equal to the repurchase price, including accrued interest. Reverse
repurchase agreements involve the risk that the market value of the securities
sold by the Fund may decline below the repurchase price of those securities.
Debt Securities and Convertible Securities
------------------------------------------
The Fund may invest in investment grade debt and convertible securities of
domestic and foreign issuers. The convertible securities in which the Fund may
invest include any debt securities or preferred stock which may be converted
into common stock or which carry the right to purchase common stock. Convertible
securities entitle the holder to exchange the securities for a specified number
of shares of common stock, usually of the same company, at specified prices
within a certain period of time. Debt obligations rated in the lowest of the top
four investment grade ratings ("Baa" by Moody's and "BBB" by S&P), commonly
known as "junk bonds," are considered to have some speculative characteristics
and may be more sensitive to adverse economic change than higher rated
securities. The Fund will sell in an orderly fashion
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as soon as possible any convertible and non-convertible debt securities it holds
if they are downgraded below "Baa" by Moody's or below "BBB" by S&P. Foreign
debt and convertible securities are generally unrated.
Forward Currency Transactions
-----------------------------
The Fund will conduct its currency exchange transactions either on a spot
(i.e., cash) basis at the rate prevailing in the currency exchange markets, or
by entering into forward currency contracts. A forward foreign currency contract
involves an obligation to purchase or sell a specific currency for a set price
at a future date. In this respect, forward currency contracts are similar to
foreign currency futures contracts; however, unlike futures contracts which are
traded on recognized commodities exchanges, forward currency contracts are
traded in the interbank market conducted directly between currency traders
(usually large commercial banks) and their customers. Also, forward currency
contracts usually involve delivery of the currency involved instead of cash
payment as in the case of futures contracts.
The Fund's participation in forward currency contracts will be limited to
hedging involving either specific transactions or portfolio positions.
Transaction hedging involves the purchase or sale of foreign currency with
respect to specific receivables or payables of the Fund generally arising in
connection with the purchase or sale of its portfolio securities. The purpose of
transaction hedging is to "lock in" the U.S. dollar equivalent price of such
specific securities. Position hedging is the sale of foreign currency with
respect to portfolio security positions denominated or quoted in that currency.
The Fund will not speculate in foreign currency exchange transactions.
Transaction and position hedging will not be limited to an overall percentage of
the Fund's assets, but will be employed as necessary to correspond to particular
transactions or positions. The Fund may not hedge its currency positions to an
extent greater than the aggregate market value (at the time of entering into the
forward contract) of the securities held in its portfolio denominated, quoted
in, or currently convertible into that particular currency. When the Fund
engages in forward currency transactions, certain asset segregation requirements
must be satisfied to ensure that the use of foreign currency transactions is
unleveraged. When the Fund takes a long position in a forward currency contract,
it must maintain a segregated account containing liquid assets equal to the
purchase price of the contract, less any margin or deposit. When the Fund takes
a short position in a forward currency contract, the Fund must maintain a
segregated account containing liquid assets in an amount equal to the market
value of the currency underlying such contract (less any margin or deposit),
which amount must be at least equal to the market price at which the short
position was established. Asset segregation requirements are not applicable when
the Fund "covers" a forward currency position generally by entering into an
offsetting position.
The transaction costs to the Fund of engaging in forward currency
transactions vary with factors such as the currency involved, the length of the
contract period and prevailing currency market conditions. Because currency
transactions are usually conducted on a principal basis, no fees or commissions
are involved. The use of forward currency contracts does not eliminate
fluctuations in the underlying prices of the securities being hedged, but it
does establish a rate of exchange that can be achieved in the future. Thus,
although forward currency contracts
5
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used for transaction or position hedging purposes may limit the risk of loss due
to an increase in the value of the hedged currency, at the same time they limit
potential gain that might result were the contracts not entered into. Further,
the Adviser may be incorrect in its expectations as to currency fluctuations,
and the Fund may incur losses in connection with its currency transactions that
it would not otherwise incur. If a price movement in a particular currency is
generally anticipated, the Fund may not be able to contract to sell or purchase
that currency at an advantageous price.
At or before the maturity of a forward sale contract, the Fund may sell a
portfolio security and make delivery of the currency, or retain the security and
offset its contractual obligation to deliver the currency by purchasing a second
contract pursuant to which the Fund will obtain, on the same maturity date, the
same amount of the currency which it is obligated to deliver. If the Fund
retains the portfolio security and engages in an offsetting transaction, the
Fund, at the time of execution of the offsetting transaction, will incur a gain
or a loss to the extent that movement has occurred in forward contract prices.
Should forward prices decline during the period between the Fund's entering into
a forward contract for the sale of a currency and the date it enters into an
offsetting contract for the purchase of the currency, the Fund will realize a
gain to the extent the price of the currency it has agreed to sell exceeds the
price of the currency it has agreed to purchase. Should forward prices increase,
the Fund will suffer a loss to the extent the price of the currency it has
agreed to sell is less than the price of the currency it has agreed to purchase
in the offsetting contract. The foregoing principles generally apply also to
forward purchase contracts.
Futures Contracts and Related Options
-------------------------------------
The Fund may invest in futures contracts and options thereon. The Fund may
enter into interest rate futures contracts and other types of financial futures
contracts, including foreign currency futures contracts, as well as any index or
foreign market futures which are available on recognized exchanges or in other
established financial markets. A futures contract on foreign currency creates a
binding obligation on one party to deliver, and a corresponding obligation on
another party to accept delivery of, a stated quantity of a foreign currency for
an amount fixed in U.S. dollars. Foreign currency futures, which operate in a
manner similar to interest rate futures contracts, may be used by the Fund to
hedge against exposure to fluctuations in exchange rates between the U.S. dollar
and other currencies arising from multinational transactions.
Futures contracts will not be entered into for speculative purposes, but to
hedge risks associated with the Fund's securities investments. The Fund will
engage in futures transactions only to the extent permitted by the Commodity
Futures Trading Commission ("CFTC") and the Securities and Exchange Commission
("SEC"). When investing in futures contracts, the Fund must satisfy certain
asset segregation requirements to ensure that the use of futures is unleveraged.
When the Fund takes a long position in a futures contract, it must maintain a
segregated account containing liquid assets equal to the purchase price of the
contract, less any margin or deposit. When the Fund takes a short position in a
futures contract, the Fund must maintain a segregated account containing liquid
assets in an amount equal to the market
6
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value of the securities underlying such contract (less any margin or deposit),
which amount must be at least equal to the market price at which the short
position was established. Asset segregation requirements are not applicable when
the Fund "covers" an options or futures position generally by entering into an
offsetting position. The Fund will limit its hedging transactions in futures
contracts and related options so that, immediately after any such transaction,
the aggregate initial margin that is required to be posted by the Fund under the
rules of the exchange on which the futures contract (or futures option) is
traded, plus any premiums paid by the Fund on its open futures options
positions, does not exceed 5% of the Fund's total assets, after taking into
account any unrealized profits and unrealized losses on the Fund's open
contracts (and excluding the amount that a futures option is "in-the-money" at
the time of purchase). An option to buy a futures contract is "in-the-money" if
the then-current purchase price of the underlying futures contract exceeds the
exercise or strike price; an option to sell a futures contract is "in-the-money"
if the exercise or strike price exceeds the then-current purchase price of the
contract that is the subject of the option. In addition, the use of futures
contracts is further restricted to the extent that no more than 10% of the
Fund's total assets may be hedged.
Positions in futures contracts may be closed out only on an exchange which
provides a secondary market for such futures. However, there can be no assurance
that a liquid secondary market will exist for any particular futures contract at
any specific time. Thus, it may not be possible to close a futures position. In
the event of adverse price movements, the Fund would continue to be required to
make daily cash payments to maintain its required margin. In such situations, if
the Fund has insufficient cash, it may have to sell portfolio securities to meet
daily margin requirements at a time when it may be disadvantageous to do so. In
addition, the Fund may be required to make delivery of the instruments
underlying futures contracts it holds. The inability to close options and
futures positions also could have an adverse impact on the Fund's ability to
effectively hedge.
Transactions in futures as a hedging device may subject the Fund to a
number of risks. Successful use of futures by the Fund is subject to the ability
of the Adviser to correctly predict movements in the direction of the market.
For example, if the Fund has hedged against the possibility of a decline in the
market adversely affecting securities held by it and securities prices increase
instead, the Fund will lose part or all of the benefit to the increased value of
its securities which it has hedged because it will have approximately equal
offsetting losses in its futures positions. There may be an imperfect
correlation, or no correlation at all, between movements in the price of the
futures contracts (or options) and movements in the price of the instruments
being hedged. In addition, investments in futures may subject the Fund to losses
due to unanticipated market movements which are potentially unlimited. Further,
there is no assurance that a liquid market will exist for any particular futures
contract (or option) at any particular time. Consequently, the Fund may realize
a loss on a futures transaction that is not offset by a favorable movement in
the price of securities which it holds or intends to purchase or may be unable
to close a futures position in the event of adverse price movements. In
addition, in some situations, if the Fund has insufficient cash, it may have to
sell securities to meet daily variation margin requirements at a time when it
may be disadvantageous to do so. Such sales of securities may be, but will not
necessarily be, at increased prices which reflect the rising market.
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As noted above, the risk of loss in trading futures contracts in some
strategies can be substantial, due both to the low margin deposits required, and
the extremely high degree of leverage involved in futures pricing. As a result,
a relatively small price movement in a futures contract may result in immediate
and substantial loss (as well as gain) to the investor. For example, if at the
time of purchase, 10% of the value of the futures contract is deposited as
margin, a subsequent 10% decrease in the value of the futures contract would
result in a total loss of the margin deposit, before any deduction for the
transaction costs, if the account were then closed out. A 15% decrease would
result in a loss equal to 150% of the original margin deposit, before any
deduction for the transaction costs, if the contract were closed out. Thus, a
purchase or sale of a futures contract may result in losses in excess of the
amount invested in the contract.
Utilization of futures transactions by the Fund involves the risk of loss
of margin deposits in the event of bankruptcy of a broker with whom the Fund has
an open position in a futures contract or related option.
Most futures exchanges limit the amount of fluctuation permitted in futures
contract prices during a single trading day. The daily limit establishes the
maximum amount that the price of a futures contract may vary either up or down
from the previous day's settlement price at the end of a trading session. Once
the daily limit has been reached in a particular type of contract, no trades may
be made on that day at a price beyond that limit. The daily limit governs only
price movement during a particular trading day and therefore does not limit
potential losses, because the limit may prevent the liquidation of unfavorable
positions. Futures contract prices have occasionally moved to the daily limit
for several consecutive trading days with little or no trading, thereby
preventing prompt liquidation of futures positions and subjecting some futures
traders to substantial losses.
The trading of futures contracts is also subject to the risk of trading
halts, suspensions, exchange or clearing house equipment failures, government
intervention, insolvency of a brokerage firm or clearing house or other
disruptions of normal trading activity, which could at times make it difficult
or impossible to liquidate existing positions or to recover excess variation
margin payments.
See Exhibit B for further discussion of futures contracts and options.
Government Obligations
----------------------
The Fund may invest in U.S. government obligations, including U.S. Treasury
bonds, notes and bills and the obligations of Federal Home Loan Banks, Federal
Farm Credit Banks, Federal Land Banks, the Federal Housing Administration, the
Farmers Home Administration, the Export-Import Bank of the United States, the
Small Business Administration, the Government National Mortgage Association, the
Federal National Mortgage Association, the General Services Administration, the
Student Loan Marketing Association, the Central Bank for Cooperatives, the
Federal Home Loan Mortgage Corporation, the Federal Intermediate Credit Banks
and the Maritime Administration. Obligations of certain agencies and
instrumentalities of
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the U.S. Government, such as those of the Government National Mortgage
Association, are supported by the right of the issuer to borrow from the
Treasury; others, such as those of the Federal National Mortgage Association,
are supported by the discretionary authority of the U.S. Government to purchase
the agency's obligations; still others, such as those of the Student Loan
Marketing Association, are supported only by the credit of the instrumentality.
No assurance can be given that the U.S. Government would provide financial
support to U.S. Government-sponsored instrumentalities if it is not obligated to
do so by law.
Illiquid Securities
-------------------
The Fund will not knowingly invest more than 15% of the value of its net
assets in securities that are illiquid. A security will be considered illiquid
if it may not be disposed of within seven days at approximately the value at
which the Fund has valued the security. The Fund may purchase securities which
are not registered under the Securities Act of 1933, as amended (the "1933
Act"), but which can be sold to "qualified institutional buyers" in accordance
with Rule 144A under the Act. Any such security will not be considered illiquid
so long as it is determined by the Adviser, acting under guidelines approved and
monitored by the Board, that an adequate trading market exists for that
security. This investment practice could have the effect of increasing the level
of illiquidity in the Fund during any period that qualified institutional buyers
are no longer interested in purchasing these restricted securities.
Investment Company Securities
-----------------------------
The Fund may invest in securities issued by other investment companies that
invest in high-quality, short-term debt securities and which determine their net
asset value per share based on the amortized cost or penny-rounding method
(i.e., money market funds). In addition to the advisory fees and other expenses
the Fund bears directly in connection with its own operations, as a shareholder
of another investment company, the Fund would bear its pro rata portion of the
other investment company's advisory fees and other expenses. As such, the Fund's
shareholders would indirectly bear the expenses of the Fund and the other
investment company, some or all of which would be duplicative. Such securities
will be acquired by the Fund within the limits prescribed by the 1940 Act, which
include, subject to certain exceptions, a prohibition against the Fund investing
more than 10% of the value of its total assets in such securities.
Money Market Instruments
------------------------
The Fund may invest in "money market instruments," which include, among
other things, bank obligations, commercial paper and corporate bonds with
remaining maturities of 13 months or less.
Bank obligations include bankers' acceptances, negotiable certificates of
deposit, and non-negotiable time deposits earning a specified return and issued
by a U.S. bank which is a member of the Federal Reserve System or insured by the
Bank Insurance Fund of the FDIC, or by a savings and loan association or savings
bank which is insured by the Savings Association
9
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Insurance Fund of the FDIC. Bank obligations also include U.S. dollar-
denominated obligations of foreign branches of U.S. banks and obligations of
domestic branches of foreign banks. Investments in bank obligations of foreign
branches of domestic financial institutions or of domestic branches of foreign
banks are limited so that no more than 5% of the value of the Fund's total
assets may be invested in any one branch, and no more than 20% of the Fund's
total assets at the time of purchase may be invested in the aggregate in such
obligations (see Investment Limitation No. 11 below under "Investment
Limitations"). Investments in time deposits are limited to no more than 5% of
the value of the Fund's total assets at the time of purchase.
Bankers' acceptances are negotiable drafts or bills of exchange, normally
drawn by an importer or exporter to pay for specific merchandise, which are
"accepted" by a bank, meaning, in effect, that the bank unconditionally agrees
to pay the face value of the instrument on maturity. Fixed time deposits are
bank obligations payable at a stated maturity date and bearing interest at a
fixed rate. Fixed time deposits may be withdrawn on demand by the investor, but
may be subject to early withdrawal penalties which vary depending upon market
conditions and the remaining maturity of the obligation. There are no
contractual restrictions on the right to transfer a beneficial interest in a
fixed time deposit to a third party, although there is no market for such
deposits. Bank notes and bankers' acceptances rank junior to domestic deposit
liabilities of the bank and equal with other senior, unsecured obligations of
the bank. Bank notes are not insured by the FDIC or any other insurer. Deposit
notes are insured by the FDIC only to the extent of $100,000 per depositor per
bank. Certificates of deposit issued by domestic branches of domestic banks do
not benefit materially, and certificates of deposit issued by foreign branches
of domestic banks do not benefit at all, from the FDIC.
Investments by the Fund in commercial paper will consist of issues that are
rated "A-2" or better by S&P or "Prime-2" or better by Moody's. In addition, the
Fund may acquire unrated commercial paper that is determined by the Adviser at
the time of purchase to be of comparable quality to rated instruments that may
be acquired by the Fund
Commercial paper may include variable and floating rate instruments. While
there may be no active secondary market with respect to a particular instrument
purchased by the Fund, the Fund may, from time to time as specified in the
instrument, demand payment of the principal of the instrument or may resell the
instrument to a third party. The absence of an active secondary market, however,
could make it difficult for the Fund to dispose of the instrument if the issuer
defaulted on its payment obligation or during periods that the Fund is not
entitled to exercise its demand rights, and the Fund could, for this or other
reasons, suffer a loss with respect to such instrument.
Options
-------
The Fund may purchase put and call options listed on a national securities
exchange and issued by the Options Clearing Corporation. Such purchases would be
in an amount not exceeding 5% of the Fund's net assets. Such options may relate
to particular securities or to various stock and bond indices. Purchase of
options is a highly specialized
10
<PAGE>
activity which entails greater than ordinary investment risks, including a
substantial risk of a complete loss of the amounts paid as premiums to the
writer of the options. Regardless of how much the market price of the underlying
security increases or decreases, the option buyer's risk is limited to the
amount of the original investment for the purchase of the option. However,
options may be more volatile than the underlying securities, and therefore, on a
percentage basis, an investment in options may be subject to greater fluctuation
than an investment in the underlying securities. A listed call option gives the
purchaser of the option the right to buy from a clearing corporation, and the
writer has the obligation to sell to the clearing corporation, the underlying
security at the stated exercise price at any time prior to the expiration of the
option, regardless of the market price of the security. The premium paid to the
writer is in consideration for undertaking the obligations under the option
contract. A listed put option gives the purchaser the right to sell to a
clearing corporation the underlying security at the stated exercise price at any
time prior to the expiration date of the option, regardless of the market price
of the security. Put and call options purchased by the Fund will be valued at
the last sale price or, in the absence of such a price, at the mean between bid
and asked prices.
The Fund may engage in writing covered call options (options on securities
owned by the Fund) and enter into closing purchase transactions with respect to
such options. Such options must be listed on a national securities exchange and
issued by the Options Clearing Corporation. The aggregate value of the
securities subject to options written by the Fund may not exceed 25% of the
value of its net assets. By writing a covered call option, the Fund forgoes the
opportunity to profit from an increase in the market price of the underlying
security above the exercise price except insofar as the premium represents such
a profit, and it will not be able to sell the underlying security until the
option expires or is exercised or the Fund effects a closing purchase
transaction by purchasing an option of the same series.
When the Fund writes a covered call option, it may terminate its obligation
to sell the underlying security prior to the expiration date of the option by
executing a closing purchase transaction, which is effected by purchasing on an
exchange an option of the same series (i.e., same underlying security, exercise
price and expiration date) as the option previously written. Such a purchase
does not result in the ownership of an option. A closing purchase transaction
will ordinarily be effected to realize a profit on an outstanding call option,
to prevent an underlying security from being called, to permit the sale of the
underlying security or to permit the writing of a new call option containing
different terms on such underlying security. The cost of such a liquidation
purchase plus transaction costs may be greater than the premium received upon
the original option, in which event the writer will have incurred a loss on the
transaction. An option position may be closed out only on an exchange which
provides a secondary market for an option of the same series. There is no
assurance that a liquid secondary market on an exchange will exist for any
particular option. A covered option writer, unable to effect a closing purchase
transaction, will not be able to sell the underlying security until the option
expires or the underlying security is delivered upon exercise, with the result
that the writer in such circumstances will be subject to the risk of market
decline in the underlying security during such period. The Fund will write an
option on a particular security only if the Adviser believes that a liquid
secondary market will exist on an exchange for options of the same series, which
will permit the Fund to make a closing purchase transaction in order to close
out its position.
11
<PAGE>
When the Fund writes an option, an amount equal to the net premium (the
premium less the commission) received by the Fund is included in the liability
section of the Fund's statement of assets and liabilities as a deferred credit.
The amount of the deferred credit will be subsequently marked to market to
reflect the current value of the option written. The current value of the traded
option is the last sale price or, in the absence of a sale, the average of the
closing bid and asked prices. If an option expires on the stipulated expiration
date, or if the Fund enters into a closing purchase transaction, the Fund will
realize a gain (or loss if the cost of a closing purchase transaction exceeds
the net premium received when the option is sold), and the deferred credit
related to such option will be eliminated. If an option is exercised, the Fund
may deliver the underlying security from its portfolio or purchase the
underlying security in the open market. In either event, the proceeds of the
sale will be increased by the net premium originally received, and the Fund will
realize a gain or loss. Premiums from expired call options written by the Fund
and net gains from closing purchase transactions are treated as short-term
capital gains for federal income tax purposes, and losses on closing purchase
transactions are short-term capital losses. The use of covered call options is
not a primary investment technique of the Fund and such options will normally be
written on underlying securities as to which the Adviser does not anticipate
significant short-term capital appreciation.
Options on Futures Contracts
----------------------------
The Fund may purchase options on the futures contracts described above. A
futures option gives the holder, in return for the premium paid, the right to
buy (call) from or sell (put) to the writer of the option a futures contract at
a specified price at any time during the period of the option. Upon exercise,
the writer of the option is obligated to pay the difference between the cash
value of the futures contract and the exercise price. Like the buyer or seller
of a futures contract, the holder, or writer, of an option has the right to
terminate its position prior to the scheduled expiration of the option by
selling, or purchasing, an option of the same series, at which time the person
entering into the closing transaction will realize a gain or loss.
Investments in futures options involve some of the same considerations that
are involved in connection with investments in futures contracts (for example,
the existence of a liquid secondary market). In addition, the purchase of an
option also entails the risk that changes in the value of the underlying futures
contract will not be fully reflected in the value of the option purchased.
Depending on the pricing of the option compared to either the futures contract
upon which it is based, or upon the price of the instruments being hedged, an
option may or may not be less risky than ownership of the futures contract or
such instruments. In general, the market prices of options can be expected to be
more volatile than the market prices on the underlying futures contract.
Compared to the purchase or sale of futures contracts, however, the purchase of
call or put options on futures contracts may frequently involve less potential
risk to the Fund because the maximum amount at risk is the premium paid for the
options (plus transaction costs). Although permitted by its fundamental
investment policies, the Fund does not currently intend to write futures
options, and will not do so in the future absent any necessary regulatory
approvals.
12
<PAGE>
Portfolio Turnover
------------------
The Fund may sell a portfolio investment immediately after its acquisition
if the Adviser believes that such a disposition is consistent with the
investment objective of the Fund. Portfolio investments may be sold for a
variety of reasons, such as a more favorable investment opportunity or other
circumstances bearing on the desirability of continuing to hold such
investments. The annual portfolio turnover rate for the Fund is not expected to
exceed 100%. A rate of 100% indicates that the equivalent of all of the Fund's
assets have been sold and reinvested in a calendar year. A high rate of
portfolio turnover may involve correspondingly greater brokerage commission
expenses and other transaction costs, which must be borne directly by the Fund
and ultimately by its shareholders. High portfolio turnover may result in the
realization of substantial net capital gains. To the extent net short-term
capital gains are realized, any distributions resulting from such gains are
considered ordinary income for federal income tax purposes. (See "Additional
Information Concerning Taxes.")
Repurchase Agreements
---------------------
The Fund may agree to purchase portfolio securities subject to the seller's
agreement to repurchase them at a mutually agreed upon date and price
("repurchase agreements"). The Fund will enter into repurchase agreements only
with financial institutions that are deemed to be creditworthy by the Adviser,
pursuant to guidelines established by the Company's Board of Directors. The Fund
will not enter into repurchase agreements with the Adviser or any of its
affiliates. Repurchase agreements with remaining maturities in excess of seven
days will be considered illiquid securities and will be subject to the
limitations described below under "Illiquid Securities." The repurchase price
under a repurchase agreement generally equals the price paid by the Fund plus
interest negotiated on the basis of current short-term rates (which may be more
or less than the rate on the securities underlying the repurchase agreement).
Securities subject to repurchase agreements are held by the Fund's
custodian (or sub-custodian) or in the Federal Reserve/Treasury book-entry
system. The seller under a repurchase agreement will be required to maintain the
value of the securities which are subject to the agreement and held by the Fund
at not less than the repurchase price. Default or bankruptcy of the seller
would, however, expose the Fund to possible delay in connection with the
disposition of the underlying securities or loss to the extent that proceeds
from a sale of the underlying securities were less than the repurchase price
under the agreement. Repurchase agreements are considered loans by the Fund
under the 1940 Act.
Securities Lending
------------------
To increase return on its portfolio securities, the Fund may lend its
portfolio securities to broker/dealers pursuant to agreements requiring the
loans to be continuously secured by collateral equal at all times in value to at
least the market value of the securities loaned. Collateral for such loans may
include cash, securities of the U.S. government, its agencies or
instrumentalities, or an irrevocable letter of credit issued by a bank, or any
combination thereof. Such loans will not be made if, as a result, the aggregate
of all outstanding loans of the Fund
13
<PAGE>
exceeds 30% of the value of its total assets. When the Fund lends its
securities, it continues to receive interest or dividends on the securities lent
and may simultaneously earn interest on the investment of the cash loan
collateral, which will be invested in readily marketable, high-quality, short-
term obligations. Although voting rights, or rights to consent, attendant to
lent securities pass to the borrower, such loans may be called at any time and
will be called so that the securities may be voted by the Fund if a material
event affecting the investment is to occur.
There may be risks of delay in receiving additional collateral or in
recovering the securities loaned or even a loss of rights in the collateral
should the borrower of the securities fail financially. However, loans are made
only to borrowers deemed by the Adviser to be of good standing and when, in the
Adviser's judgment, the income to be earned from the loan justifies the
attendant risks.
When-Issued and Forward Transactions
------------------------------------
The Fund may purchase eligible securities on a "when-issued" basis and may
purchase or sell securities on a "forward commitment" basis. These transactions
involve a commitment by a Fund to purchase or sell particular securities with
payment and delivery taking place in the future, beyond the normal settlement
date, at a stated price and yield. Securities purchased on a "forward
commitment" or "when-issued" basis are recorded as an asset and are subject to
changes in value based upon changes in the general level of interest rates. When
the Fund agrees to purchase securities on a "when-issued" or "forward
commitment" basis, the custodian will set aside cash or liquid portfolio
securities equal to the amount of the commitment in a separate account.
Normally, the custodian will set aside portfolio securities to satisfy a
purchase commitment and, in such case, the Fund may be required subsequently to
place additional assets in the separate account in order to ensure that the
value of the account remains equal to the amount of the Fund's commitment. It
may be expected that the Fund's net assets will fluctuate to a greater degree
when it sets aside portfolio securities to cover such purchase commitments than
when it sets aside cash. Because the Fund will set aside cash or liquid assets
to satisfy its purchase commitments in the manner described above, its liquidity
and ability to manage its portfolio might be affected in the event its forward
commitments or commitments to purchase "when-issued" securities ever exceed 25%
of the value of its assets.
It is expected that "forward commitments" and "when-issued" purchases will
not exceed 25% of the value of the Fund's total assets absent unusual market
conditions, and that the length of such commitments will not exceed 45 days. The
Fund does not intend to engage in "when-issued" purchases and "forward
commitments" for speculative purposes, but only in furtherance of its investment
objective.
The Fund will purchase securities on a "when-issued" or "forward
commitment" basis only with the intention of completing the transaction. If
deemed advisable as a matter of investment strategy, however, the Fund may
dispose of or renegotiate a commitment after it is entered into, and may sell
securities it has committed to purchase before those securities are delivered to
the Fund on the settlement date. In these cases, the Fund may realize a taxable
capital gain or loss.
14
<PAGE>
When the Fund engages in "when-issued" or "forward commitment"
transactions, it relies on the other party to consummate the trade. Failure of
such other party to do so may result in the Fund incurring a loss or missing an
opportunity to obtain a price considered to be advantageous.
The market value of the securities underlying a "when-issued" purchase or a
"forward commitment" to purchase securities and any subsequent fluctuations in
their market value are taken into account when determining the market value of
the Fund starting on the day the Fund agrees to purchase the securities. The
Fund does not earn interest on the securities it has committed to purchase until
they are paid for and delivered on the settlement date
INVESTMENT LIMITATIONS
----------------------
The investment limitations enumerated below are matters of fundamental
policy. Fundamental investment limitations may be changed with respect to the
Fund only by a vote of the holders of a majority of the Fund's outstanding
shares. As used herein, a "vote of the holders of a majority of the outstanding
shares" of the Company or the Fund means, with respect to the approval of an
investment advisory agreement or a change in a fundamental investment policy,
the affirmative vote of the lesser of (a) more than 50% of the outstanding
shares of the Company or the Fund, or (b) 67% or more of the shares of the
Company or the Fund present at a meeting if more than 50% of the outstanding
shares of the Company or the Fund are represented at the meeting in person or by
proxy.
The following investment limitations are fundamental with respect to the
Fund. The Fund may not:
1. Make loans, except that (i) the Fund may purchase or hold debt
securities in accordance with its investment objective and policies, and may
enter into repurchase agreements with respect to obligations issued or
guaranteed by the U.S. government, its agencies or instrumentalities, and (ii)
the Fund may lend portfolio securities in accordance with its investment
objective and policies.
2. Purchase any securities which would cause more than 25% of the value of
its total assets at the time of purchase to be invested in the securities of one
or more issuers conducting their principal business activities in the same
industry, provided that (i) the Fund will concentrate its investments in the
securities of biotechnology companies, and (ii) there is no limitation with
respect to securities issued or guaranteed by the U.S. government, any state,
territory or possession of the United States, the District of Columbia or any of
their authorities, agencies, instrumentalities or political subdivisions, and
repurchase agreements secured by such securities.
3. Borrow money or mortgage, pledge or hypothecate its assets except to the
extent permitted under the 1940 Act. Optioned stock held in escrow is not deemed
to be a pledge. Any borrowed money will be used to meet redemption requests.
15
<PAGE>
4. Act as an underwriter of securities within the meaning of the 1933 Act,
except insofar as it might be deemed to be an underwriter upon disposition of
certain portfolio securities acquired within the limitation on purchases of
restricted securities and except to the extent that the purchase of obligations
directly from the issuer thereof in accordance with its investment objective,
policies and limitations may be deemed to be underwriting.
5. Purchase or sell real estate, except that (i) the Fund may purchase
securities of issuers which deal in real estate and may purchase securities
which are secured by real estate or interests therein, and (ii) the Fund may
hold and sell any real estate it acquires as a result of the Fund's ownership of
such securities.
6. Issue any senior securities, except insofar as any borrowing in
accordance with the Fund's investment limitations might be considered to be the
issuance of a senior security.
7. Purchase or sell commodities or commodities futures contracts or invest
in oil, gas, or other mineral exploration or development programs; provided,
however, that the Fund may: (i) purchase publicly traded securities of companies
engaging in whole or in part in such activities or invest in liquidating trust
receipts, certificates of beneficial ownership or other instruments in
accordance with its investment objective and policies, and (ii) purchase and
sell options, forward contracts, futures contracts and futures options.
8. Invest in companies for the purpose of exercising management or control.
9. Acquire any other investment company or investment company security,
except in connection with a merger, consolidation, reorganization, or
acquisition of assets or where otherwise permitted by the 1940 Act.
The following investment limitations may be changed by the Board of
Directors without shareholder approval. The Fund may not:
10. Invest in obligations of foreign branches of financial institutions or
in domestic branches of foreign banks, if immediately after such purchase (i)
more than 5% of the value of its total assets would be invested in obligations
of any one foreign branch of the financial institution or domestic branch of a
foreign bank; or (ii) more than 20% of its total assets would be invested in
foreign branches of financial institutions or in domestic branches of foreign
banks. In addition, the Fund will not purchase portfolio securities while
borrowings in excess of 5% of its total assets are outstanding.
The following investment limitation is an operating policy of the Funds.
The Fund may not:
11. Purchase securities on margin (except in connection with purchases of
futures or options in compliance with its investment strategies), make short
sales of securities, or maintain a short position;
16
<PAGE>
* * *
With respect to the Fund's fundamental Investment Limitation No. 3, asset
coverage of at least 300% (as defined in the 1940 Act), inclusive of any amounts
borrowed, must be maintained at all times.
With respect to the Fund's fundamental Investment Limitation No. 9, the
Fund may purchase or otherwise acquire any security issued by any other
investment company (the "acquired company") only if, immediately after such
purchase or acquisition, the Fund owns in the aggregate: (i) less than 3% of the
total outstanding voting stock of the acquired company; (ii) securities issued
by the acquired company having an aggregate value of less than 5% of the value
of the Fund's total assets; and (iii) securities issued by the acquired company
and all other investment companies having an aggregate value of less than 10% of
the value of the Fund's total assets.
For the purpose of Investment Limitation No. 5, the prohibition of
purchases of real estate includes acquisition of limited partnership interests
in partnerships formed with a view toward investing in real estate, but does not
prohibit purchases of shares in real estate investment trusts.
In addition to the above investment limitations, the Fund currently intends
to refrain from entering into arbitrage transactions.
If a percentage limitation is satisfied at the time of investment, a later
increase or decrease in such percentage resulting from a change in value of the
Fund's securities will not constitute a violation of such limitation.
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION
----------------------------------------------
Shares are continuously offered for sale by Edgewood Services, Inc. (the
"Distributor"), a registered broker-dealer and the Company's sponsor and
distributor. The Distributor is a wholly-owned subsidiary of Federated
Investors, Inc. and is located at 5800 Corporate Drive, Pittsburgh, PA
15237-5829. The Distributor has agreed to use appropriate efforts to solicit all
purchase orders.
At various times the Distributor may implement programs under which a
dealer's sales force may be eligible to win nominal awards for certain sales
efforts or under which the Distributor will make payments to any dealer that
sponsors sales contests or recognition programs conforming to criteria
established by the Distributor, or that participates in sales programs sponsored
by the Distributor. The Distributor in its discretion may also from time to
time, pursuant to objective criteria established by the Distributor, pay fees to
qualifying dealers for certain services or activities which are primarily
intended to result in sales of shares of the Fund. If any such program is made
available to any dealer, it will be made available to all dealers on the same
terms and conditions. Payments made under such programs will be made by the
Distributor out of its own assets and not out of the assets of the Fund.
17
<PAGE>
In addition, the Distributor may offer to pay a fee from its own assets to
financial institutions for the continuing investment of customers' assets in the
Fund or for providing substantial marketing, sales and operational support. The
support may include initiating customer accounts, participating in sales,
educational and training seminars, providing sales literature, and engineering
computer software programs that emphasize the attributes of the Fund. Such
assistance will be predicated upon the amount of shares the financial
institution sells or may sell, and/or upon the type and nature of sales or
marketing support furnished by the financial institution.
Purchase of Shares
------------------
Shares of the Fund are offered for sale at their net asset value per share
next computed after a purchase request is received in good order by the
Company's sub-transfer agent or by an authorized broker or designated
intermediary. The Distributor has established several procedures for purchasing
shares in order to accommodate different types of investors.
Shares may be sold to customers ("Customers") of financial institutions
("Shareholder Organizations"). Shares are also offered for sale directly to
institutional investors and to members of the general public. Different types of
Customer accounts at the Shareholder Organizations may be used to purchase
shares, including eligible agency and trust accounts. In addition, Shareholder
Organizations may automatically "sweep" a Customer's account not less frequently
than weekly and invest amounts in excess of a minimum balance agreed to by the
Shareholder Organization and its Customer in shares selected by the Customer.
Investors purchasing shares may include officers, directors, or employees of the
particular Shareholder Organization.
Shares may be purchased directly by individuals ("Direct Investors") or by
institutions ("Institutional Investors" and, collectively with Direct Investors,
"Investors"). Shares may also be purchased by Customers of the Adviser, its
affiliates and correspondent banks, and other Shareholder Organizations that
have entered into agreements with the Company. A Shareholder Organization may
elect to hold of record shares for its Customers and to record beneficial
ownership of shares on the account statements provided by it to its Customers.
If it does so, it is the Shareholder Organization's responsibility to transmit
to the Distributor all purchase requests for its Customers and to transmit, on a
timely basis, payment for such requests to Chase Global Funds Services Company
("CGFSC"), the Fund's sub-transfer agent, in accordance with the procedures
agreed to by the Shareholder Organization and the Distributor. Confirmations of
all such Customer purchases (and redemptions) will be sent by CGFSC to the
particular Shareholder Organization. As an alternative, a Shareholder
Organization may elect to establish its Customers' accounts of record with
CGFSC. In this event, even if the Shareholder Organization continues to place
its Customers' purchase (and redemption) requests with the Fund, CGFSC will send
confirmations of such transactions and periodic account statements directly to
the shareholders of record. Shares in the Fund bear the expense of fees payable
to Shareholder Organizations for such services. See "Management of the Fund -
Shareholder Organizations."
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<PAGE>
Redemption Procedures
---------------------
Customers of Shareholder Organizations holding shares of record may redeem
all or part of their investments in the Fund in accordance with procedures
governing their accounts at the Shareholder Organizations. It is the
responsibility of the Shareholder Organizations to transmit redemption requests
to CGFSC and credit such Customer accounts with the redemption proceeds on a
timely basis. Redemption requests for Institutional Investors must be
transmitted to CGFSC by telephone at (800) 446-1012 or by terminal access. No
charge for wiring redemption payments to Shareholder Organizations or
Institutional Investors is imposed by the Company, although Shareholder
Organizations may charge a Customer's account for wiring redemption proceeds.
Information relating to such redemption services and charges, if any, is
available from the Shareholder Organizations. An Investor redeeming shares
through a registered investment adviser or certified financial planner may incur
transaction charges in connection with such redemptions. Such Investors should
contact their registered investment adviser or certified financial planner for
further information on transaction fees. Investors may redeem all or part of
their shares in accordance with any of the procedures described below (these
procedures also apply to Customers of Shareholder Organizations for whom
individual accounts have been established with CGFSC).
As discussed in the Prospectus, a redemption request for an amount in
excess of $50,000 per account, or for any amount if the proceeds are to be sent
elsewhere than the address of record, must be accompanied by signature
guarantees from any eligible guarantor institution approved by CGFSC in
accordance with its Standards, Procedures and Guidelines for the Acceptance of
Signature Guarantees ("Signature Guarantee Guidelines"). Eligible guarantor
institutions generally include banks, broker/dealers, credit unions, national
securities exchanges, registered securities associations, clearing agencies and
savings associations. All eligible guarantor institutions must participate in
the Securities Transfer Agents Medallion Program ("STAMP") in order to be
approved by CGFSC pursuant to the Signature Guarantee Guidelines. Copies of the
Signature Guarantee Guidelines and information on STAMP can be obtained from
CGFSC at (800) 446-1012 or by sending a written request to CGFSC at P.O. Box
2798, Boston, MA 02208-2798.
CGFSC may require additional supporting documents for redemptions made by
corporations, executors, administrators, trustees and guardians. A redemption
request will not be deemed to be properly received until CGFSC receives all
required documents in good order. Payment for shares redeemed will ordinarily be
made by mail within five Business Days after receipt by CGFSC of the redemption
request in good order. Questions with respect to the proper form for redemption
requests should be directed to CGFSC at (800) 446-1012 (from overseas, call
(617) 557-8280).
Direct Investors who have so indicated on the Application, or have
subsequently arranged in writing to do so, may redeem shares by instructing
CGFSC by wire or telephone to wire the redemption proceeds directly to the
Direct Investor's account at any commercial bank in
19
<PAGE>
the United States. Institutional Investors may also redeem shares by instructing
CGFSC by telephone at (800) 446-1012 or by terminal access.
During periods of substantial economic or market change, telephone
redemptions may be difficult to complete. If an Investor is unable to contact
CGFSC by telephone, the Investor may also deliver the redemption request to
CGFSC in writing at the address noted above.
Other Redemption Information
----------------------------
The Company may suspend the right of redemption or postpone the date of
payment for shares for more than seven days during any period when (a) trading
on the New York Stock Exchange (the "NYSE") is restricted by applicable rules
and regulations of the SEC; (b) the NYSE is closed for other than customary
weekend and holiday closings; (c) the SEC has by order permitted such
suspension; or (d) an emergency exists as determined by the SEC.
In the event that shares are redeemed in cash at their net asset value, a
shareholder may receive in payment for such shares an amount that is more or
less than his original investment due to changes in the market prices of the
Fund's portfolio securities.
The Company reserves the right to honor any request for redemption or
repurchase of the Fund's shares by making payment in whole or in part in
securities chosen by the Company and valued in the same way as they would be
valued for purposes of computing the Fund's net asset value (a "redemption in
kind"). If payment is made in securities, a shareholder may incur transaction
costs in converting these securities into cash. The Company has filed a notice
of election with the SEC under Rule 18f-1 of the 1940 Act. Therefore, the Fund
is obligated to redeem its shares solely in cash up to the lesser of $250,000 or
1% of its net asset value during any 90-day period for any one shareholder of
the Fund.
Under certain circumstances, the Company may, in its discretion, accept
securities as payment for shares. Securities acquired in this manner will be
limited to securities issued in transactions involving a bona fide
reorganization or statutory merger, or other transactions involving securities
that meet the investment objective and policies of the Fund when acquiring such
securities.
INVESTOR PROGRAMS
-----------------
Systematic Withdrawal Plan
--------------------------
An Investor who owns shares with a value of $10,000 or more may begin a
Systematic Withdrawal Plan. The withdrawal can be on a monthly, quarterly,
semiannual or annual basis. There are four options for such systematic
withdrawals. The Investor may request:
(1) A fixed-dollar withdrawal;
20
<PAGE>
(2) A fixed-share withdrawal;
(3) A fixed-percentage withdrawal (based on the current value of the
account); or
(4) A declining-balance withdrawal.
Prior to participating in a Systematic Withdrawal Plan, the Investor must
deposit any outstanding certificates for shares with CGFSC. Under this Plan,
dividends and distributions are automatically reinvested in additional shares of
the Fund. Amounts paid to investors under this Plan should not be considered as
income. Withdrawal payments represent proceeds from the sale of shares, and
there will be a reduction of the shareholder's equity in the Fund involved if
the amount of the withdrawal payments exceeds the dividends and distributions
paid on the shares and the appreciation of the Investor's investment in the
Fund. This in turn may result in a complete depletion of the shareholder's
investment. An Investor may not participate in a program of systematic investing
in the Fund while at the same time participating in the Systematic Withdrawal
Plan with respect to an account in the Fund. Customers of Shareholder
Organizations may obtain information on the availability of, and the procedures
and fees relating to, the Systematic Withdrawal Plan directly from their
Shareholder Organizations.
Exchange Privilege
------------------
Investors and Customers of Shareholder Organizations may exchange Shares
having a value of at least $500 for shares of the Shares Class of any other
portfolio of the Company or Excelsior Tax-Exempt Funds, Inc. ("Excelsior
Tax-Exempt Fund" and, collectively with the Company, the "Companies") or for
shares of the Shares Class of Excelsior Institutional Trust. An exchange
involves a redemption of all or a portion of the shares in the Fund and the
investment of the redemption proceeds in shares of another portfolio. The
redemption will be made at the per share net asset value of the shares being
redeemed next determined after the exchange request is received in good order.
The shares of the portfolio to be acquired will be purchased at the per share
net asset value of those shares next determined after receipt of the exchange
request in good order.
Shares may be exchanged by wire, telephone or mail and must be made to
accounts of identical registration. There is no exchange fee imposed by the
Companies or Excelsior Institutional Trust. In order to prevent abuse of this
privilege to the disadvantage of other shareholders, the Companies and Excelsior
Institutional Trust reserve the right to limit the number of exchange requests
of Investors to no more than six per year. Customers of Shareholder
Organizations may obtain information on the availability of, and the procedures
and fees relating to, such program directly from their Shareholder
Organizations.
For federal income tax purposes, exchanges are treated as sales on which
the shareholder will realize a gain or loss, depending upon whether the value of
the shares to be given up in exchange is more or less than the basis in such
shares at the time of the exchange. Generally, a shareholder may include sales
loads incurred upon the purchase of shares in his or
21
<PAGE>
her tax basis for such shares for the purpose of determining gain or loss on a
redemption, transfer or exchange of such shares. However, if the shareholder
effects an exchange of shares for shares of another portfolio of the Companies
within 90 days of the purchase and is able to reduce the sales load otherwise
applicable to the new shares (by virtue of the Companies' exchange privilege),
the amount equal to such reduction may not be included in the tax basis of the
shareholder's exchanged shares but may be included (subject to the limitation)
in the tax basis of the new shares.
Retirement Plans
----------------
Shares are available for purchase by Investors in connection with the
following tax-deferred prototype retirement plans offered by United States Trust
Company of New York ("U.S. Trust New York"):
. IRAs (including "rollovers" from existing retirement plans) for
individuals and their spouses;
. Profit Sharing and Money-Purchase Plans for corporations and
self-employed individuals and their partners to benefit themselves and
their employees; and
. Keogh Plans for self-employed individuals.
Investors investing in the Fund pursuant to Profit Sharing and
Money-Purchase Plans and Keogh Plans are not subject to the minimum investment
and forced redemption provisions described above. The minimum initial investment
for IRAs is $250 and the minimum subsequent investment is $50. Detailed
information concerning eligibility, service fees and other matters related to
these plans can be obtained by calling (800) 446-1012 (from overseas, call (617)
557-8280). Customers of Shareholder Organizations may purchase shares of the
Fund pursuant to retirement plans if such plans are offered by their Shareholder
Organizations.
Automatic Investment Program
----------------------------
The Automatic Investment Program permits Investors to purchase shares
(minimum of $50 per transaction) at regular intervals selected by the Investor.
The minimum initial investment for an Automatic Investment Program account is
$50. Provided the Investor's financial institution allows automatic withdrawals,
shares are purchased by transferring funds from an Investor's checking, bank
money market or NOW account designated by the Investor. At the Investor's
option, the account designated will be debited in the specified amount, and
shares will be purchased, once a month, on either the first or fifteenth day, or
twice a month, on both days.
The Automatic Investment Program is one means by which an Investor may use
"dollar cost averaging" in making investments. Instead of trying to time market
performance, a fixed dollar amount is invested in shares at predetermined
intervals. This may help Investors to reduce their average cost per share
because the agreed upon fixed investment amount allows
22
<PAGE>
more shares to be purchased during periods of lower share prices and fewer
shares during periods of higher prices. In order to be effective, dollar cost
averaging should usually be followed on a sustained, consistent basis. Investors
should be aware, however, that shares bought using dollar cost averaging are
purchased without regard to their price on the day of investment or to market
trends. In addition, while Investors may find dollar cost averaging to be
beneficial, it will not prevent a loss if an Investor ultimately redeems his
shares at a price which is lower than their purchase price. The Company may
modify or terminate this privilege at any time or charge a service fee, although
no such fee currently is contemplated. An Investor may also implement the dollar
cost averaging method on his own initiative or through other entities.
Additional Information
----------------------
Customers of Shareholder Organizations may obtain information on the
availability of, and the procedures and fees relating to, the above programs
directly from their Shareholder Organizations.
DESCRIPTION OF CAPITAL STOCK
----------------------------
The Company's Charter authorizes its Board of Directors to issue up to
thirty-five billion full and fractional shares of common stock, $.001 par value
per share, and to classify or reclassify any unissued shares of the Company into
one or more classes or series by setting or changing in any one or more respects
their respective preferences, conversion or other rights, voting powers,
restrictions, limitations as to dividends, qualifications, and terms and
conditions of redemption. The Company's authorized common stock is currently
classified into 48 series of shares representing interests in 20 investment
portfolios.
Each share in the Fund represents an equal proportionate interest in the
Fund with other shares of the same class, and is entitled to such dividends and
distributions out of the income earned on the assets belonging to the Fund as
are declared in the discretion of the Company's Board of Directors.
Shares have no preemptive rights and only such conversion or exchange
rights as the Board of Directors may grant in its discretion. When issued for
payment as described in the Prospectus, shares will be fully paid and
non-assessable. In the event of a liquidation or dissolution of the Fund, its
shareholders are entitled to receive the assets available for distribution
belonging to the Fund and a proportionate distribution, based upon the relative
asset values of the Company's portfolios, of any general assets of the Company
not belonging to any particular portfolio of the Company which are available for
distribution. In the event of a liquidation or dissolution of the Company, its
shareholders will be entitled to the same distribution process.
Shareholders of the Company are entitled to one vote for each full share
held, and fractional votes for fractional shares held, and will vote in the
aggregate and not by class, except as otherwise required by the 1940 Act or
other applicable law or when the matter to be voted
23
<PAGE>
upon affects only the interests of the shareholders of a particular class.
Voting rights are not cumulative and, accordingly, the holders of more than 50%
of the aggregate of the Company's shares may elect all of the Company's
directors, regardless of votes of other shareholders.
Rule 18f-2 under the 1940 Act provides that any matter required to be
submitted to the holders of the outstanding voting securities of an investment
company such as the Company shall not be deemed to have been effectively acted
upon unless approved by the holders of a majority of the outstanding shares of
each portfolio affected by the matter. A portfolio is affected by a matter
unless it is clear that the interests of each portfolio in the matter are
substantially identical or that the matter does not affect any interest of the
portfolio. Under the Rule, the approval of an investment advisory agreement or
any change in a fundamental investment policy would be effectively acted upon
with respect to a portfolio only if approved by a majority of the outstanding
shares of such portfolio. However, the Rule also provides that the ratification
of the appointment of independent public accountants and the election of
directors may be effectively acted upon by shareholders of the Company voting
without regard to class.
The Company's Charter authorizes its Board of Directors, without
shareholder approval (unless otherwise required by applicable law), to: (a) sell
and convey the assets of the Fund to another management investment company for
consideration which may include securities issued by the purchaser and, in
connection therewith, to cause all outstanding shares of the Fund to be redeemed
at a price which is equal to their net asset value and which may be paid in cash
or by distribution of the securities or other consideration received from the
sale and conveyance; (b) sell and convert the Fund's assets into money and, in
connection therewith, to cause all outstanding shares of the Fund to be redeemed
at their net asset value; or (c) combine the assets belonging to the Fund with
the assets belonging to another portfolio of the Company, if the Board of
Directors reasonably determines that such combination will not have a material
adverse effect on shareholders of any portfolio participating in such
combination, and, in connection therewith, to cause all outstanding shares of
the Fund to be redeemed at their net asset value or converted into shares of
another class of the Company's common stock at net asset value. The exercise of
such authority by the Board of Directors will be subject to the provisions of
the 1940 Act, and the Board of Directors will not take any action described in
this paragraph unless the proposed action has been disclosed in writing to the
Fund's shareholders at least 30 days prior thereto.
Notwithstanding any provision of Maryland law requiring a greater vote of
the Company's common stock (or of the shares of the Fund voting separately as a
class) in connection with any corporate action, unless otherwise provided by law
(for example, by Rule 18f-2, discussed above) or by the Company's Charter, the
Company may take or authorize such action upon the favorable vote of the holders
of more than 50% of the outstanding common stock of the Company voting without
regard to class.
Certificates for shares will not be issued unless expressly requested in
writing to CGFSC and will not be issued for fractional shares.
24
<PAGE>
MANAGEMENT OF THE FUND
----------------------
Directors and Officers
----------------------
The business and affairs of the Fund are managed under the direction of the
Company's Board of Directors. The directors and executive officers of the
Company, their addresses, ages, principal occupations during the past five
years, and other affiliations are as follows:
Principal Occupation
Position with During Past 5 Years and
Name and Address the Company Other Affiliations
---------------- ----------- ------------------
Frederick S. Wonham1 Chairman of the Retired; Chairman of the Boards
c/o Excelsior Funds, Inc. Board, President (since 1997) and President,
73 Tremont Street and Treasurer Treasurer and Director (since
Boston, MA 02108-3913 1995) of the Company and
Age: 69 Excelsior Tax-Exempt Funds,
Inc.; Chairman of the Board
(since 1997), President,
Treasurer and Trustee (since
1995) of Excelsior Institutional
Trust; President, Treasurer and
Trustee of Excelsior Funds (from
1995 to 1999); Vice Chairman of
U.S. Trust Corporation and U.S.
Trust New York (from February
1990 until September 1995); and
Chairman, U.S. Trust Company
(from March 1993 to May 1997).
---------------------------
1 This director is considered to be an "interested person" of the Company as
defined in the 1940 Act.
25
<PAGE>
Principal Occupation
Position with During Past 5 Years and
Name and Address the Company Other Affiliations
---------------- ----------- ------------------
Rodman L. Drake Director Director of the Company and
Continuation Investments Excelsior Tax-Exempt Funds, Inc.
Group, Inc. (since 1996); Trustee of
1251 Avenue of the Americas Excelsior Institutional Trust
9th Floor (since 1994); Trustee of
New York, NY 10020 Excelsior Funds (from 1994 to
Age: 57 1999); Director, Parsons
Brinkerhoff, Inc. (engineering
firm) (since 1995); President,
Continuation Investments Group,
Inc. (since 1997); President,
Mandrake Group (investment and
consulting firm) (1994-1997);
Chairman, MetroCashcard
International Inc. (since 1999);
Director, Hotelivision, Inc.
(since 1999); Director, Alliance
Group Services, Inc. (since
1998); Director, Hyperion Total
Return Fund, Inc. and three
other funds for which Hyperion
Capital Management, Inc. serves
as investment adviser (since
1991); Co-Chairman, KMR Power
Corporation (power plants) (from
1993 to 1996); Director, The
Latin America Smaller Companies
Fund, Inc. (from 1993 to 1998);
Member of Advisory Board,
Argentina Private Equity Fund
L.P. (from 1992 to 1996) and
Garantia L.P. (Brazil) (from
1993 to 1996); and Director,
Mueller Industries, Inc. (from
1992 to 1994).
Joseph H. Dugan Director Retired; Director of the Company
c/o Excelsior Funds, Inc. and Excelsior Tax-Exempt Fund
73 Tremont Street (since 1984); Director of UST
Boston, MA 02108-3913 Master Variable Series, Inc.
Age: 75 (from 1994 to June 1997); and
Trustee of Excelsior
Institutional Trust (since
1995).
Wolfe J. Frankl Director Retired; Director of the Company
c/o Excelsior Funds, Inc. and Excelsior Tax-Exempt Funds,
73 Tremont Street Inc. (since 1986); Director of
Boston, MA 02108-3913 UST Master Variable Series, Inc.
Age: 79 (from 1994 to June 1997);
Trustee of Excelsior
Institutional Trust (since
1995); Director, Deutsche Bank
Financial, Inc. (since 1989);
Director, The Harbus Corporation
(since 1951); and Trustee, HSBC
Funds Trust and HSBC Mutual
Funds Trust (since 1988).
Morrill Melton Hall, Jr. Director Director of the Company and
Comprehensive Health Excelsior Tax-Exempt Funds, Inc.
Services, Inc. (since July 30, 2000); Trustee
8229 Boone Blvd., Suite 700 of Excelsior Institutional Trust
Vienna, VA 22182 (since July 30, 2000); Chief
Age: 55 Executive Officer, Comprehensive
Health Services, Inc. (health
care management and
administration)
26
<PAGE>
Principal Occupation
Position with During Past 5 Years and
Name and Address the Company Other Affiliations
---------------- ----------- ------------------
Jonathan Piel Director Director of the Company and
c/o Excelsior Funds, Inc. Excelsior Tax-Exempt Funds, Inc.
73 Tremont Street (since 1996); Trustee of
Boston, MA 02108-3913 Excelsior Institutional Trust
Age: 61 (since 1994); Trustee of
Excelsior Funds (from 1994 to
1999); Vice President and
Editor, Scientific American,
Inc. (from 1986 to 1994);
Director, Group for The South
Fork, Bridgehampton, New York
(since 1993); and Member,
Advisory Committee, Knight
Journalism Fellowships,
Massachusetts Institute of
Technology (since 1984).
Robert A. Robinson Director Director of the Company and
Church Pension Group Excelsior Tax-Exempt Funds, Inc.
800 Second Avenue (since 1987); Director of UST
New York, NY 10017 Master Variable Series, Inc.
Age: 74 (from 1994 to June 1997);
Trustee of Excelsior
Institutional Trust (since
1995); President Emeritus, The
Church Pension Fund and its
affiliated companies (since
1966); Trustee, H.B. and F.H.
Bugher Foundation and Director
of its wholly owned subsidiaries
-- Rosiclear Lead and Flourspar
Mining Co. and The Pigmy
Corporation (property
management) (since 1984);
Director, Morehouse Publishing
Co. (from 1974 to 1998);
Trustee, HSBC Funds Trust and
HSBC Mutual Funds Trust (since
1982); and Director, Infinity
Funds, Inc. (since 1995).
Alfred C. Tannachion/2/ Director Retired; Director of the Company
c/o Excelsior Funds, Inc. and Excelsior Tax-Exempt Funds,
73 Tremont Street Inc. (since 1985); Chairman of
Boston, MA 02108-3913 the Board of the Company and
Age: 74 Excelsior Tax-Exempt Funds, Inc.
(from 1991 to 1997) and
Excelsior Institutional Trust
(from 1996 to 1997); President
and Treasurer of Excelsior
Funds, Inc. and Excelsior
Tax-Exempt Funds, Inc. (from
1994 to 1997) and Excelsior
Institutional Trust (from 1996
to 1997); Chairman of the Board,
President and Treasurer of UST
Master Variable Series, Inc.
(from 1994 to 1997); and Trustee
of Excelsior Institutional Trust
(since 1995).
--------------------------
2 This director is considered to be an "interested person" of the Company as
defined in the 1940 Act.
27
<PAGE>
Principal Occupation
Position with During Past 5 Years and
Name and Address the Company Other Affiliations
---------------- ----------- ------------------
W. Bruce McConnel, III Secretary Partner of the law firm of
One Logan Square Drinker Biddle & Reath LLP.
18th and Cherry Streets
Philadelphia, PA
19103-6996
Age: 57
Michael P. Malloy Assistant Partner of the law firm of
One Logan Square Secretary Drinker Biddle & Reath LLP.
18th and Cherry Streets
Philadelphia, PA 19103-6996
Age: 41
Eddie Wang Assistant Manager of Blue Sky Compliance,
Chase Global Funds Secretary Chase Global Funds Services
Services Company Company (November 1996 to
73 Tremont Street present); and Officer and
Boston, MA 02108-3913 Manager of Financial Reporting,
Age: 39 Investors Bank & Trust Company
(from January 1991 to November
1996).
Patricia M. Leyne Assistant Vice President, Senior Manager
Chase Global Funds Treasurer of Fund Administration, Chase
Services Company Global Funds Services Company
73 Tremont Street (since August 1999); Assistant
Boston, MA 02108-3913 Vice President, Senior Manager
Age: 33 of Fund Administration, Chase
Global Funds Services Company
(from July 1998 to August 1999);
Assistant Treasurer, Manager of
Fund Administration, Chase
Global Funds Services Company
(from November 1996 to July
1998); Supervisor, Chase Global
Funds Services Company (from
September 1995 to November
1996); Fund Administrator, Chase
Global Funds Services Company
(from February 1993 to September
1995).
Each director receives an annual fee of $9,000 from each of Excelsior
Funds, Inc. and Excelsior Tax-Exempt Funds, Inc. and $4,000 from Excelsior
Institutional Trust plus a meeting fee of $1,500 from each of Excelsior Funds,
Inc. and Excelsior Tax-Exempt Funds, Inc. and $250 from Excelsior Institutional
Trust for each meeting attended and is reimbursed for expenses incurred in
attending meetings. The Chairman of the Board is entitled to receive an
additional $5,000 per annum from each of the foregoing Companies for services in
such capacity. Prior to December 1999, each of Messrs. Drake, Piel and Wonham
received $4,000 from Excelsior Funds plus a per-Company meeting fee of $250 and
each of these persons was reimbursed for expenses incurred in attending meetings
of Excelsior Funds. The Chairman of the Board of Excelsior Funds received $5,000
per annum for services in such capacity. In addition, Messrs. Drake, Piel and
Robinson each receive $2,000 per annum for their services on the Company's
Nominating Committee. Drinker Biddle & Reath LLP, of which Messrs. McConnel and
Malloy are partners, receives legal fees as counsel to the Company.
28
<PAGE>
The employees of CGFSC do not receive any compensation from the Company for
acting as officers of the Company. No person who is currently an officer,
director or employee of the Adviser serves as an officer, director or employee
of the Company. As of September 30, 2000, the directors and officers of the
Company as a group owned beneficially less than 1% of the outstanding shares of
each fund of the Company, and less than 1% of the outstanding shares of all
funds of the Company in the aggregate.
The following chart provides certain information about the fees received by
the Company's directors in the most recently completed fiscal year.
<TABLE>
<CAPTION>
Pension or Retirement Total Compensation from
Aggregate Benefits Accrued as Estimated Annual the Company
Name of Compensation from Part of Benefits Upon and Fund Complex*
Person/Position the Company Fund Expenses Retirement Paid to Directors
--------------- ----------- ------------- ---------- -----------------
<S> <C> <C> <C> <C>
Donald L. Campbell***
Director $9,000 None None $22,000(3)**
Rodman L. Drake
Director $15,500 None None $38,750(4)**
Joseph H. Dugan
Director $16,500 None None $38,250(3)**
Wolfe J. Frankl
Director $15,000 None None $35,000(3)**
Morrill Melton Hall, Jr.
Director**** 0 None None 0
Jonathan Piel
Director $17,000 None None $42,000(4)**
Robert A. Robinson
Director $17,000 None None $39,500(3)**
Alfred C. Tannachion
Director $16,500 None None $38,250(3)**
Frederick S. Wonham
Chairman of the Board,
President and Treasurer $21,500 None None $52,000(4)**
</TABLE>
29
<PAGE>
------------
* The "Fund Complex" consists of the Company, Excelsior Tax-Exempt Fund and
Excelsior Institutional Trust, and, until December 15, 1999, Excelsior
Funds.
** Number of investment companies in the Fund Complex for which director
served as director or trustee.
*** Mr. Campbell resigned as a director of the Companies as of July 31, 2000.
**** Mr. Hall became a director/trustee of the Companies on July 31, 2000.
Investment Advisory and Administration Agreements
-------------------------------------------------
U. S. Trust of New York and U.S. Trust Company (collectively with U.S.
Trust New York, "U.S. Trust" or the "Adviser") serve as investment advisers to
the Fund. In the Investment Advisory Agreement, the Adviser has agreed to
provide the services described in the Prospectus. The Adviser has also agreed to
pay all expenses incurred by it in connection with its activities under the
Agreement other than the cost of securities, including brokerage commissions,
purchased for the Fund.
For the services provided and expenses assumed pursuant to the Investment
Advisory Agreement, the Adviser is entitled to be paid a fee computed daily and
paid monthly, at the annual rate of 1.00% of the average daily net assets of the
Fund.
From time to time, the Adviser may voluntarily or contractually waive all
or a portion of the advisory fees payable to it by the Fund, which waiver may be
terminated at any time.
The Investment Advisory Agreement provides that the Adviser shall not be
liable for any error of judgment or mistake of law or for any loss suffered by
the Fund in connection with the performance of such Agreement, except that U.S.
Trust New York and U.S. Trust Company shall be jointly, but not severally,
liable for a loss resulting from a breach of fiduciary duty with respect to the
receipt of compensation for advisory services or a loss resulting from willful
misfeasance, bad faith or gross negligence in the performance of their duties or
from reckless disregard by them of their duties and obligations thereunder. In
addition, the Adviser has undertaken in the Investment Advisory Agreement to
maintain its policy and practice of conducting its Asset Management Group
independently of its Banking Group.
U.S. Trust Corporation is a wholly-owned subsidiary of The Charles Schwab
Corporation ("Schwab"). Charles R. Schwab is the founder, Chairman and Co-Chief
Executive Officer and a Director and significant shareholder of Schwab. As a
result of his positions and share ownership, Mr. Schwab may be deemed to be a
controlling person of Schwab and its subsidiaries. Through its principal
subsidiary Charles Schwab & Co., Inc., Schwab is the nation's fourth largest
financial services firm and the nation's largest electronic brokerage firm, in
each case measured by customer assets.
30
<PAGE>
CGFSC, Federated Services Company (an affiliate of the Distributor) and
U.S. Trust Company (collectively, the "Administrators") serve as the Company's
administrators and provide the Fund with general administrative and operational
assistance. Until July 31, 2000, Federated Services Company's subsidiary,
Federated Administrative Services, served as the Company's administrator. On
July 31, 2000, Federated Services Company assumed all of its subsidiary's rights
and obligations under the Administration Agreement. Under the Administration
Agreement, the Administrators have agreed to maintain office facilities for the
Fund, furnish the Fund with statistical and research data, clerical, accounting
and bookkeeping services, and certain other services required by the Fund, and
to compute the net asset value, net income and realized capital gains or losses,
if any, of the Fund. The Administrators prepare semiannual reports to the SEC,
prepare federal and state tax returns, prepare filings with state securities
commissions, arrange for and bear the cost of processing share purchase and
redemption orders, maintain the Fund's financial accounts and records, and
generally assist in the Fund's operations.
Prior to May 16, 1997, CGFSC, Federated Administrative Services and U.S.
Trust New York served as the Company's administrators pursuant to an
administration agreement substantially similar to the Administration Agreement
currently in effect for the Company.
The Administrators also provide administrative services to the other
investment portfolios of the Company and to all of the investment portfolios of
Excelsior Tax-Exempt Fund and Excelsior Institutional Trust which are also
advised by U.S. Trust and its affiliates and distributed by the Distributor. For
services provided to all of the investment portfolios of the Company, Excelsior
Tax-Exempt Fund and Excelsior Institutional Trust (except for the international
portfolios of the Company and Excelsior Institutional Trust), the Administrators
are entitled jointly to fees, computed daily and paid monthly, based on the
combined aggregate average daily net assets of the three companies (excluding
the international portfolios of the Company and Excelsior Institutional Trust)
as follows:
Combined Aggregate Average Daily Net Assets
of the Company, Excelsior Tax-Exempt Fund and
Excelsior Institutional Trust (excluding
the international portfolios of the Company
and Excelsior Institutional Trust)
----------------------------------
Annual Fee
----------
First $200 million.......................................... 0.200%
Next $200 million........................................... 0.175%
Over $400 million........................................... 0.150%
Administration fees payable to the Administrators by each portfolio of the
Company, Excelsior Tax-Exempt Fund and Excelsior Institutional Trust are
allocated in proportion to their relative average daily net assets at the time
of determination. From time to
31
<PAGE>
time, the Administrators may voluntarily waive all or a portion of the
administration fee payable to them by a Fund, which waivers may be terminated at
any time.
Shareholder Organizations
-------------------------
The Company has entered into agreements with certain Shareholder
Organizations. Such agreements require the Shareholder Organizations to provide
shareholder administrative services to their Customers who beneficially own
shares in consideration for the Fund's payment of not more than the annual rate
of 0.40% of the average daily net assets of the Fund's shares beneficially owned
by Customers of the Shareholder Organization. Such services may include: (a)
acting as recordholder of shares; (b) assisting in processing purchase, exchange
and redemption transactions; (c) transmitting and receiving funds in connection
with Customer orders to purchase, exchange or redeem shares; (d) providing
periodic statements showing a Customer's account balances and confirmations of
transactions by the Customer; (e) providing tax and dividend information to
shareholders as appropriate; (f) transmitting proxy statements, annual reports,
updated prospectuses and other communications from the Company to Customers; and
(g) providing or arranging for the provision of other related services. It is
the responsibility of Shareholder Organizations to advise Customers of any fees
that they may charge in connection with a Customer's investment.
The Company's agreements with Shareholder Organizations are governed by an
Administrative Services Plan (the "Plan") adopted by the Company. Pursuant to
the Plan, the Company's Board of Directors will review, at least quarterly, a
written report of the amounts expended under the Company's agreements with
Shareholder Organizations and the purposes for which the expenditures were made.
In addition, the arrangements with Shareholder Organizations will be approved
annually by a majority of the Company's directors, including a majority of the
directors who are not "interested persons" of the Company as defined in the 1940
Act and have no direct or indirect financial interest in such arrangements (the
"Disinterested Directors").
Any material amendment to the Company's arrangements with Shareholder
Organizations must be approved by a majority of the Company's Board of Directors
(including a majority of the Disinterested Directors). So long as the Company's
arrangements with Shareholder Organizations are in effect, the selection and
nomination of the members of the Company's Board of Directors who are not
"interested persons" (as defined in the 1940 Act) of the Company will be
committed to the discretion of such Disinterested Directors.
Personal Trading
----------------
The Company, the Adviser and the Distributor have adopted written codes of
ethics under Rule 17j-1 of the 1940 Act, which prescribes general rules of
conduct and sets forth guidelines with respect to personal securities trading by
"Access Persons" thereof. An Access Person, as defined in the Code of Ethics of
the Company, is an individual who is (1) a director or officer of the Company,
(2) an employee of the Company or of any Company in a control relationship to
the Company who, in connection with his or her regular functions or duties,
32
<PAGE>
makes, participates in, or obtains information regarding the purchase or sale of
a security by the Company or whose functions relate to the making of any
recommendations with respect to such purchases or sales; and (3) any natural
person in a control relationship to the Company who obtains information
concerning recommendations made to the Company with regard to the purchase or
sale of a security. The guidelines contain restrictions on personal securities
trading including restrictions on: (i) securities being considered for purchase
or sale, or purchased or sold, by any investment company advised by the Adviser,
(ii) initial public offerings, (iii) private placements, (iv) blackout periods
and (v) short-term trading profits. These guidelines are substantially similar
to those contained in the Report of the Advisory Group on Personal Investing
issued by the Investment Company Institute's Advisory Panel. CGFSC and the
Adviser report to the Board of Directors on a quarterly basis, as to whether
there were any violations of the Code of Ethics by Access Persons of the Company
or the Adviser during the quarter.
Expenses
--------
Except as otherwise noted, the Adviser and the Administrators bear all
expenses in connection with the performance of their services. The Fund bears
the expenses incurred in its operations. Expenses of the Fund include: taxes;
interest; fees (including fees paid to the Company's directors and officers who
are not affiliated with the Distributor or the Administrators); SEC fees; state
securities qualifications fees; costs of preparing and printing prospectuses for
regulatory purposes and for distribution to shareholders; advisory,
administration and administrative servicing fees; charges of the custodian,
transfer agent, and dividend disbursing agent; certain insurance premiums;
outside auditing and legal expenses; costs of independent pricing services;
costs of shareholder reports and shareholder meetings; and any extraordinary
expenses. The Fund also pays for brokerage fees and commissions in connection
with the purchase of portfolio securities.
Custodian and Transfer Agent
----------------------------
The Chase Manhattan Bank ("Chase"), a wholly-owned subsidiary of The Chase
Manhattan Corporation, serves as custodian of the Fund's assets. Under the
Custodian Agreement, Chase has agreed to: (i) maintain a separate account or
accounts in the name of the Fund; (ii) make receipts and disbursements of money
on behalf of the Fund; (iii) collect and receive all income and other payments
and distributions on account of the Fund's portfolio securities; (iv) respond to
correspondence from securities brokers and others relating to its duties; (v)
maintain certain financial accounts and records; and (vi) make periodic reports
to the Company's Board of Directors concerning the Fund's operations. Chase may,
at its own expense, open and maintain custody accounts with respect to the Fund
with other banks or trust companies, provided that Chase shall remain liable for
the performance of all its custodial duties under the Custodian Agreement,
notwithstanding any delegation. Communications to the custodian should be
directed to Chase, Mutual Funds Service Division, 3 Chase MetroTech Center, 8th
Floor, Brooklyn, NY 11245.
33
<PAGE>
U.S. Trust New York serves as the Fund's transfer agent and dividend
disbursing agent. In such capacity, U.S. Trust New York has agreed to: (i) issue
and redeem shares; (ii) address and mail all communications by the Fund to its
shareholders, including reports to shareholders, dividend and distribution
notices, and proxy materials for its meetings of shareholders; (iii) respond to
correspondence by shareholders and others relating to its duties; (iv) maintain
shareholder accounts; and (v) make periodic reports to the Company's Board of
Directors concerning the Fund's operations. For its transfer agency, dividend
disbursing, and subaccounting services, U.S. Trust New York is entitled to
receive $15.00 per annum per account and subaccount. In addition, U.S. Trust New
York is entitled to be reimbursed for its out-of-pocket expenses for the cost of
forms, postage, processing purchase and redemption orders, handling of proxies,
and other similar expenses in connection with the above services. U.S. Trust New
York is located at 114 W. 47th Street, New York, New York 10036.
U.S. Trust New York may, at its own expense, delegate its transfer agency
obligations to another transfer agent registered or qualified under applicable
law, provided that U.S. Trust New York shall remain liable for the performance
of all of its transfer agency duties under the Transfer Agency Agreement,
notwithstanding any delegation. Pursuant to this provision in the agreement,
U.S. Trust New York has entered into a sub-transfer agency arrangement with
CGFSC, an affiliate of Chase, with respect to accounts of shareholders who are
not Customers of U.S. Trust New York. CGFSC is located at 73 Tremont Street,
Boston, Massachusetts 02108-3913. For the services provided by CGFSC, U.S. Trust
New York has agreed to pay CGFSC $15.00 per annum per account or subaccount plus
out-of-pocket expenses. CGFSC receives no fee directly from the Company for any
of its sub-transfer agency services. U.S. Trust New York may, from time to time,
enter into sub-transfer agency arrangements with third party providers of
transfer agency services.
PORTFOLIO TRANSACTIONS
----------------------
Subject to the general control of the Company's Board of Directors, the
Adviser is responsible for, makes decisions with respect to, and places orders
for all purchases and sales of all portfolio securities of the Fund.
The Fund may engage in short-term trading to achieve its investment
objective. Portfolio turnover may vary greatly from year to year as well as
within a particular year. The Fund's portfolio turnover rate may also be
affected by cash requirements for redemptions of shares and by regulatory
provisions which enable the Fund to receive certain favorable tax treatment.
Portfolio turnover will not be a limiting factor in making portfolio decisions.
Transactions on U.S. stock exchanges involve the payment of negotiated
brokerage commissions. On exchanges on which commissions are negotiated, the
cost of transactions may vary among different brokers. In executing portfolio
transactions for the Fund, the Adviser may use affiliated brokers in accordance
with the requirements of the 1940 Act. The Adviser may also take into account
the sale of Fund shares in allocating brokerage transactions.
34
<PAGE>
Transactions in domestic over-the-counter markets are generally principal
transactions with dealers, and the costs of such transactions involve dealer
spreads rather than brokerage commissions. With respect to over-the-counter
transactions, the Fund, where possible, will deal directly with the dealers who
make a market in the securities involved, except in those circumstances where
better prices and execution are available elsewhere.
The Investment Advisory Agreement between the Company and the Adviser
provides that, in executing portfolio transactions and selecting brokers or
dealers, the Adviser will seek to obtain the best net price and the most
favorable execution. The Adviser shall consider factors it deems relevant,
including the breadth of the market in the security, the price of the security,
the financial condition and execution capability of the broker or dealer and
whether such broker or dealer is selling shares of the Company, and the
reasonableness of the commission, if any, for the specific transaction and on a
continuing basis.
In addition, the Investment Advisory Agreement authorizes the Adviser, to
the extent permitted by law and subject to the review of the Company's Board of
Directors from time to time with respect to the extent and continuation of the
policy, to cause the Fund to pay a broker which furnishes brokerage and research
services a higher commission than that which might be charged by another broker
for effecting the same transaction, provided that the Adviser determines in good
faith that such commission is reasonable in relation to the value of the
brokerage and research services provided by such broker, viewed in terms of
either that particular transaction or the overall responsibilities of the
Adviser to the accounts as to which it exercises investment discretion. Such
brokerage and research services might consist of reports and statistics on
specific companies or industries, general summaries of groups of stocks and
their comparative earnings, or broad overviews of the stock market and the
economy.
Supplementary research information so received is in addition to and not in
lieu of services required to be performed by the Adviser and does not reduce the
investment advisory fees payable by the Fund. Such information may be useful to
the Adviser in serving the Fund and other clients and, conversely, supplemental
information obtained by the placement of business of other clients may be useful
to the Adviser in carrying out its obligations to the Fund.
Portfolio securities will not be purchased from or sold to the Adviser,
Distributor, or any of their affiliated persons (as such term is defined in the
1940 Act) acting as principal, except to the extent permitted by the SEC.
Investment decisions for the Fund are made independently from those for
other investment companies, common trust funds and other types of funds managed
by the Adviser. Such other investment companies and funds may also invest in the
same securities as the Fund. When a purchase or sale of the same security is
made at substantially the same time on behalf of the Fund and another investment
company or common trust fund, the transaction will be averaged as to price, and
available investments allocated as to amount, in a manner which the Adviser
believes to be equitable to the Fund and such other investment company or common
trust fund. In some instances, this investment procedure may adversely affect
the price paid or received by the Fund or the size of the position obtained by
the Fund. To the extent permitted by
35
<PAGE>
law, the Adviser may aggregate the securities to be sold or purchased for the
Fund with those to be sold or purchased for other investment companies or common
trust funds in order to obtain best execution.
To the extent that the Fund effects brokerage transactions with any
broker-dealer affiliated directly or indirectly with U.S. Trust, such
transactions, including the frequency thereof, the receipt of any commissions
payable in connection therewith, and the selection of the affiliated
broker-dealer effecting such transactions, will be fair and reasonable to the
shareholders of the Fund.
PORTFOLIO VALUATION
-------------------
Assets in the Fund which are traded on a recognized domestic stock exchange
are valued at the last sale price on the securities exchange on which such
securities are primarily traded or at the last sale price on the national
securities market. Securities traded only on over-the-counter markets are valued
on the basis of closing over-the-counter bid prices. Securities for which there
were no transactions are valued at the average of the most recent bid and asked
prices. An option or futures contract is valued at the last sales price quoted
on the principal exchange or board of trade on which such option or contract is
traded, or in the absence of a sale, the mean between the last bid and asked
prices. Restricted securities and securities or other assets for which market
quotations are not readily available are valued at fair value, pursuant to
guidelines adopted by the Company's Board of Directors.
Portfolio securities which are primarily traded on foreign securities
exchanges are generally valued at the preceding closing values of such
securities on their respective exchanges, except that when an event subsequent
to the time where value was so established is likely to have changed such value,
then the fair value of those securities will be determined by consideration of
other factors under the direction of the Board of Directors. A security which is
listed or traded on more than one exchange is valued at the quotation on the
exchange determined to be the primary market for such security. Investments in
debt securities having a maturity of 60 days or less are valued based upon the
amortized cost method. All other foreign securities are valued at the last
current bid quotation if market quotations are available, or at fair value as
determined in accordance with guidelines adopted by the Board of Directors. For
valuation purposes, quotations of foreign securities in foreign currency are
converted to U.S. dollars equivalent at the prevailing market rate on the day of
conversion. Some of the securities acquired by the Fund may be traded on foreign
exchanges or over-the-counter markets on days which are not Business Days. In
such cases, the net asset value of the shares may be significantly affected on
days when investors can neither purchase nor redeem the Fund's shares. The
Company's Administrators have undertaken to price the securities in the Fund,
and may use one or more independent pricing services in connection with this
service.
CGFSC and the Adviser will use the following procedures to determine the
fair value of securities subject to significant price changes or that are
unpriced. If CGFSC and the Adviser agree that the quoted price of a security is
suspect, the price of a security will be determined as follows: CGFSC will refer
to at least two independent brokers from whom it will
36
<PAGE>
obtain a price for the security. CGFSC will average the two prices and inform
the Adviser of the new price. That price will be used unless CGFSC and the
Adviser believe it is suspect. In addition, securities for which market
quotations are not readily available will be valued at their "fair value" by
CGFSC. For this purpose, "fair value" shall mean a price which, considering the
factors listed below and such other information as it believes relevant, CGFSC
and the Adviser estimate it could receive in cash within 7 days were the
securities to be sold. Such value will be cost if CGFSC and the Adviser
determine such valuation is appropriate after considering the factors listed
below. CGFSC and the Adviser shall monitor on a daily basis market changes that
may affect such valuation. At the next regularly scheduled meeting of the full
Board of Directors each valuation will be ratified or amended as appropriate.
The following are among the factors CGFSC and the Adviser shall consider when
determining the "fair value" of a security for which market quotations are not
readily available: (a) the fundamental analytical data relating to the
investment; (b) an evaluation of the forces which influence the market in which
the security is purchased and sold; (c) special reports prepared by analysts;
(d) information as to any transactions or offers with respect to the security;
and (e) the price, yield and extent of public or private trading in similar
securities of the issuer or comparable companies, and other relevant matters.
If, notwithstanding the foregoing procedure, CGFSC and the Adviser believe that
the new price is suspect, or believe that a security priced at cost should be
re-evaluated, the Adviser shall so inform the Company's Secretary and a meeting
of the Company's Board of Directors shall be called to determine what actions
should be taken.
37
<PAGE>
INDEPENDENT AUDITORS
--------------------
Ernst & Young LLP, independent auditors, 200 Clarendon Street, Boston, MA
02116, serve as auditors of the Company.
COUNSEL
-------
Drinker Biddle & Reath LLP (of which Mr. McConnel, Secretary of the
Company, and Mr. Malloy, Assistant Secretary of the Company, are partners), One
Logan Square, 18th and Cherry Streets, Philadelphia, Pennsylvania 19103, is
counsel to the Company and will pass upon the legality of the shares offered by
the Prospectus.
ADDITIONAL INFORMATION CONCERNING TAXES
---------------------------------------
The following supplements the tax information contained in the Prospectus.
For federal income tax purposes, the Fund is treated as a separate
corporate entity and has qualified and intends to continue to qualify as a
regulated investment company under the Internal Revenue Code of 1986, as amended
(the "Code"). Such qualification generally relieves the Fund of liability for
federal income taxes to the extent its earnings are distributed in accordance
with applicable requirements. If, for any reason, the Fund does not qualify for
a taxable year for the special federal tax treatment afforded regulated
investment companies, the Fund would be subject to federal tax on all of its
taxable income at regular corporate rates, without any deduction for
distributions to shareholders. In such event, dividend distributions would be
taxable as ordinary income to shareholders to the extent of the Fund's current
and accumulated earnings and profits and would be eligible for the dividends
received deduction in the case of corporate shareholders. Moreover, if the Fund
were to fail to make sufficient distributions in a year, the Fund would be
subject to corporate income taxes and/or excise taxes in respect of the
shortfall or, if the shortfall is large enough, the Fund could be disqualified
as a regulated investment company.
A 4% non-deductible excise tax is imposed on regulated investment companies
that fail to currently distribute an amount equal to specified percentages of
their ordinary taxable income and capital gain net income (excess of capital
gains over capital losses). The Fund intends to make sufficient distributions or
deemed distributions of its ordinary taxable income and any capital gain net
income prior to the end of each calendar year to avoid liability for this excise
tax.
Dividends declared in October, November or December of any year payable to
shareholders of record on a specified date in such months will be deemed to have
been received by shareholders and paid by a Fund on December 31 of such year if
such dividends are actually paid during January of the following year.
38
<PAGE>
The Fund will be required in certain cases to withhold and remit to the
U.S. Treasury 31% of taxable dividends or gross proceeds realized upon sale paid
to shareholders who have failed to provide a correct tax identification number
in the manner required, who are subject to withholding by the Internal Revenue
Service for failure properly to include on their return payments of taxable
interest or dividends, or who have failed to certify to the Fund when required
to do so either that they are not subject to backup withholding or that they are
"exempt recipients."
The Fund's transactions in options, futures contracts, and forward currency
exchange contracts will be subject to special tax rules that may affect the
amount, timing, and character of Fund income and distribution to shareholders.
In addition, foreign exchange gains or losses realized by the Fund will
generally be treated as ordinary income or losses realized by the Fund will
generally be treated as ordinary income or loss by the Fund. Investment by the
Fund in certain "passive foreign investment companies" may also have to be
limited in order to avoid a tax on the Fund. Such Fund may elect (if such
election is available) to mark to market any investments in "passive foreign
investment companies" on the last day of each year. This election may cause the
Fund to recognize income prior to the receipt of cash payments with respect to
those investments; in order to distribute this income and avoid tax on the Fund,
the Fund may be required to liquidate portfolio securities that it might
otherwise have continued to hold.
The tax principles applicable to transactions in financial instruments and
futures contacts and options that may be engaged in by the Fund, and investments
in passive foreign investment companies ("PFICs"), are complex and, in some
cases, uncertain. Such transactions and investments may cause a Fund to
recognize taxable in come prior to the receipt of cash, thereby requiring the
Fund to liquidate other positions, or to borrow money, so as to make sufficient
distributions to shareholders to avoid corporate level tax. Moreover, some or
all of the taxable income recognized may be ordinary income or short-term
capital gain, so that the distributions may be taxable to Shareholders as
ordinary income. In addition, in the case of any shares of a PFIC in which the
Fund invests, it may be liable for corporate-level tax on any ultimate gain or
distributions on the s hares if the Fund fails to make an election to recognize
income annually during the period of its ownership of the PFIC shares.
The foregoing discussion is based on federal tax laws and regulations which
are in effect on the date of this Statement of Additional Information; such laws
and regulations may be changed by legislative or administrative action.
Shareholders are advised to consult their tax advisers concerning their specific
situations and the application of state, local and foreign taxes.
PERFORMANCE INFORMATION
-----------------------
The Fund may advertise the "average annual total return" for its shares.
Such total return figure reflects the average percentage change in the value of
an investment in the Fund from the beginning date of the measuring period to the
end of the measuring period.
39
<PAGE>
Average annual total return figures will be given for the most recent one-year
period, and may be given for other periods as well (such as from the
commencement of the Fund's operations, or on a year-by-year basis). The average
annual return is computed by determining the average annual compounded rate of
return during specified periods that equates the initial amount invested to the
ending redeemable value of such investment according to the following formula:
ERV 1/n
T = [(-----) - 1]
P
Where: T = average annual total return.
ERV = ending redeemable value of a hypothetical $1,000 payment
made at the beginning of the 1, 5 or 10 year (or other)
periods at the end of the applicable period (or a fractional
portion thereof).
P = hypothetical initial payment of $1,000.
n = period covered by the computation, expressed in years.
The Fund may also advertise the "aggregate total return" for its shares for
various periods, representing the cumulative change in the value of an
investment in the Fund for the specific period. The aggregate total return is
computed by determining the aggregate compounded rates of return during
specified periods that likewise equate the initial amount invested to the ending
redeemable value of such investment. The formula for calculating aggregate total
return is as follows:
ERV
Aggregate Total Return = [(------)] - 1
P
The above calculations are made assuming that (1) all dividends and capital
gain distributions are reinvested on the reinvestment dates at the price per
share existing on the reinvestment date, (2) all recurring fees charged to all
shareholder accounts are included, and (3) for any account fees that vary with
the size of the account, a mean (or median) account size in the Fund during the
periods is reflected. The ending redeemable value (variable "ERV" in the
formula) is determined by assuming complete redemption of the hypothetical
investment after deduction of all nonrecurring charges at the end of the
measuring period.
The Fund may also from time to time include in advertisements, sales
literature and communications to shareholders a total return figure that is not
calculated according to the formula set forth above in order to compare more
accurately the Fund's performance with other measures of investment return. For
example, in comparing the Fund's total return with data
40
<PAGE>
published by Lipper Inc., CDA Investment Technologies, Inc. or Weisenberger
Investment Company Service, or with the performance of an index, the Fund may
calculate its aggregate total return for the period of time specified in the
advertisement or communication by assuming the investment of $10,000 in shares
and assuming the reinvestment of each dividend or other distribution at net
asset value on the reinvestment date. Percentage increases are determined by
subtracting the initial value of the investment from the ending value and by
dividing the remainder by the beginning value.
The total return of shares of the Fund may be compared to that of other
mutual funds with similar investment objectives and to other relevant indices or
to ratings prepared by independent services or other financial or industry
publications that monitor the performance of mutual funds. For example, the
total return of the Fund may be compared to data prepared by Lipper Inc., CDA
Investment Technologies, Inc. and Weisenberger Investment Company Service. Total
return and yield data as reported in national financial publications such as
Money Magazine, Forbes, Barron's, The Wall Street Journal and The New York
Times, or in publications of a local or regional nature, may also be used in
comparing the performance of the Fund. Advertisements, sales literature or
reports to shareholders may from time to time also include a discussion and
analysis of the Fund's performance, including, without limitation, those
factors, strategies and techniques that, together with market conditions and
events, materially affected the Fund's performance.
The Fund may also from time to time include discussions or illustrations of
the effects of compounding in advertisements. "Compounding" refers to the fact
that, if dividends or other distributions on the Fund investment are reinvested
by being paid in additional Fund shares, any future income or capital
appreciation of the Fund would increase the value, not only of the original Fund
investment, but also of the additional Fund shares received through
reinvestment. As a result, the value of a Fund investment would increase more
quickly than if dividends or other distributions had been paid in cash. The Fund
may also include discussions or illustrations of the potential investment goals
of a prospective investor, investment management techniques, policies or
investment suitability of the Fund, economic conditions, the effects of
inflation and historical performance of various asset classes, including but not
limited to, stocks, bonds and Treasury bills. From time to time advertisements,
sales literature or communications to shareholders may summarize the substance
of information contained in shareholder reports (including the investment
composition of the Fund), as well as the views of the Adviser as to current
market, economy, trade and interest rate trends, legislative, regulatory and
monetary developments, investment strategies and related matters believed to be
of relevance to the Fund. The Fund may also include in advertisements charts,
graphs or drawings which illustrate the potential risks and rewards of
investment in various investment vehicles, including but not limited to, stocks,
bonds, Treasury bills and shares of the Fund. In addition, advertisements, sales
literature or shareholder communications may include a discussion of certain
attributes or benefits to be derived by an investment in the Fund. Such
advertisements or communications may include symbols, headlines or other
material which highlight or summarize the information discussed in more detail
therein.
41
<PAGE>
Performance will fluctuate and any quotation of performance should not be
considered as representative of the Fund's future performance. Shareholders
should remember that performance is generally a function of the kind and quality
of the instruments held in a portfolio, operating expenses, and market
conditions. Any fees charged by Shareholder Organizations with respect to
accounts of Customers that have invested in shares will not be included in
calculations of performance.
MISCELLANEOUS
-------------
As used herein, "assets allocable to the Fund" means the consideration
received upon the issuance of shares in the Fund, together with all income,
earnings, profits, and proceeds derived from the investment thereof, including
any proceeds from the sale of such investments, any funds or payments derived
from any reinvestment of such proceeds, and a portion of any general assets of
the Company not belonging to a particular portfolio of the Company. In
determining the Fund's net asset value, assets allocable to the Fund are charged
with the direct liabilities in respect of the Fund and with a share of the
general liabilities of the Company which are normally allocated in proportion to
the relative asset values of the Company's portfolios at the time of allocation.
Subject to the provisions of the Company's Charter, determinations by the Board
of Directors as to the direct and allocable liabilities, and the allocable
portion of any general assets with respect to the Fund, are conclusive.
42
<PAGE>
APPENDIX A
----------
Commercial Paper Ratings
------------------------
A Standard & Poor's commercial paper rating is a current opinion of the
creditworthiness of an obligor with respect to financial obligations having an
original maturity of no more than 365 days. The following summarizes the rating
categories used by Standard and Poor's for commercial paper:
"A-1" - Obligations are rated in the highest category indicating that 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" - Obligations are 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" - Obligations exhibit 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" - Obligations are 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.
"C" - Obligations are currently vulnerable to nonpayment and are dependent
upon favorable business, financial, and economic conditions for the obligor to
meet its financial commitment on the obligation.
"D" - Obligations are 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 will be used
upon the filing of a bankruptcy petition or the taking of a similar action if
payments on an obligation are jeopardized.
Local Currency and Foreign Currency Risks:
------------------------------------------
Country risk considerations are a standard part of Standard & Poor's
analysis for credit ratings on any issuer or issue. Currency of repayment is a
key factor in this analysis. An obligor's capacity to repay foreign obligations
may be lower than its capacity to repay obligations in its local currency due to
the sovereign government's own relatively lower capacity to repay external
versus domestic debt. These sovereign risk considerations are incorporated in
the debt ratings assigned to specific issues. Foreign currency issuer ratings
are also distinguished
A-1
<PAGE>
from local currency issuer ratings to identify those instances where sovereign
risks make them different for the same issuer.
Moody's commercial paper ratings are opinions of the ability of issuers to
honor senior financial obligations and contracts. These obligations have an
original maturity not exceeding one year, unless explicitly noted. The following
summarizes the rating categories used by Moody's for commercial paper:
"Prime-1" - Issuers (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; and well-established access
to a range of financial markets and assured sources of alternate liquidity.
"Prime-2" - Issuers (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 (or supporting institutions) have an acceptable ability
for repayment of senior short-term debt 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 do not fall within any of the Prime rating
categories.
Fitch short-term ratings apply to time horizons of less than 12 months for
most obligations, or up to three years for U.S. public finance securities, and
thus places greater emphasis on the liquidity necessary to meet financial
commitments in a timely manner. The following summarizes the rating categories
used by Fitch for short-term obligations:
"F1" - Securities possess the highest credit quality. This designation
indicates the strongest capacity for timely payment of financial commitments and
may have an added "+" to denote any exceptionally strong credit feature.
"F2" - Securities possess good credit quality. This designation indicates a
satisfactory capacity for timely payment of financial commitments, but the
margin of safety is not as great as in the case of the higher ratings.
A-2
<PAGE>
"F3" - Securities possess fair credit quality. This designation indicates
that the capacity for timely payment of financial commitments is adequate;
however, near-term adverse changes could result in a reduction to non-investment
grade.
"B" - Securities possess speculative credit quality. This designation
indicates minimal capacity for timely payment of financial commitments, plus
vulnerability to near-term adverse changes in financial and economic conditions.
"C" - Securities possess high default risk. This designation indicates a
capacity for meeting financial commitments which is solely reliant upon a
sustained, favorable business and economic environment.
"D" - Securities are in actual or imminent payment default.
Corporate and Municipal Long-Term Debt Ratings
----------------------------------------------
The following summarizes the ratings used by Standard & Poor's for
corporate and municipal debt:
"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 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 inadequate capacity to meet its financial commitment on the
obligation.
A-3
<PAGE>
"B" - An obligation rated "B" is more vulnerable to nonpayment than
obligations rated "BB", but the obligor currently has the capacity to meet its
financial commitment on the obligation. Adverse business, financial or economic
conditions will likely impair the obligor's capacity or willingness to meet its
financial commitment on the obligation.
"CCC" - An obligation rated "CCC" is currently vulnerable to nonpayment,
and is dependent upon favorable business, financial and economic conditions for
the obligor to meet its financial commitment on the obligation. In the event of
adverse business, financial, or economic conditions, the obligor is not likely
to have the capacity to meet its financial commitment on the obligation.
"CC" - An obligation rated "CC" is currently highly vulnerable to
nonpayment.
"C" - An obligation rated "C" is currently highly vulnerable to nonpayment.
The "C" rating may be used to cover a situation where a bankruptcy petition has
been filed or similar action 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 on an obligation are jeopardized.
- PLUS (+) OR MINUS (-) - The ratings from "AA" through "CCC" may be
modified by the addition of a plus or minus sign to show relative standing
within the major rating categories.
- "r" - The 'r' highlights obligations that Standard & Poor's believes have
significant noncredit risks. Examples of such obligations are securities with
principal or interest return indexed to equities, commodities, or currencies;
certain swaps and options; and interest-only and principal-only mortgage
securities. The absence of an 'r' symbol should not be taken as an indication
that an obligation will exhibit no volatility or variability in total return.
- N.R. Indicates that no rating has been requested, that there is
insufficient information on which to base a rating, or that Standard & Poor's
does not rate a particular obligation as a matter of policy.
The following summarizes the ratings used by Moody's for corporate and
municipal long-term debt:
"Aaa" - Bonds are judged to be of the best quality. They carry the smallest
degree of investment risk and are generally referred to as "gilt edged."
Interest payments are protected by a large or by an exceptionally stable margin
and principal is secure. While the various protective elements are likely to
change, such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
A-4
<PAGE>
"Aa" - Bonds are judged to be of high quality by all standards. Together
with the "Aaa" group they comprise what are generally known as high-grade bonds.
They are rated lower than the best bonds because margins of protection may not
be as large as in "Aaa" securities or fluctuation of protective elements may be
of greater amplitude or there may be other elements present which make the
long-term risk appear somewhat larger than the "Aaa" securities.
"A" - Bonds 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 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.
"Ba" - Bonds 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 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 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 represent obligations which are speculative in a high degree.
Such issues are often in default or have other marked shortcomings.
"C" - Bonds 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.
Con. (...) - Bonds for which the security depends on the completion of some
act or the fulfillment of some condition are rated conditionally. These are
bonds secured by (a) earnings of projects under construction, (b) earnings of
projects unseasoned in operation experience, (c) rentals which begin when
facilities are completed, or (d) payments to which some other limiting condition
attaches. The parenthetical rating denotes probable credit stature upon
completion of construction or elimination of the basis of the condition.
Note: Moody's applies numerical modifiers 1, 2, and 3 in each generic rating
classification from "Aa" through "Caa." The modifier 1 indicates that the
obligation ranks in the higher end of its
A-5
<PAGE>
generic rating category; the modifier 2 indicates a mid-range ranking; and the
modifier 3 indicates a ranking in the lower end of its generic rating category.
The following summarizes long-term ratings used by Fitch:
"AAA" - Securities considered to be investment grade and of the highest
credit quality. These ratings denote the lowest expectation of credit risk and
are assigned only in case of exceptionally strong capacity for timely payment of
financial commitments. This capacity is highly unlikely to be adversely affected
by foreseeable events.
"AA" - Securities considered to be investment grade and of very high credit
quality. These ratings denote a very low expectation of credit risk and indicate
very strong capacity for timely payment of financial commitments. This capacity
is not significantly vulnerable to foreseeable events.
"A" - Securities considered to be investment grade and of high credit
quality. These ratings denote a low expectation of credit risk and indicate
strong capacity for timely payment of financial commitments. This capacity may,
nevertheless, be more vulnerable to changes in circumstances or in economic
conditions than is the case for higher ratings.
"BBB" - Securities considered to be investment grade and of good credit
quality. These ratings denote that there is currently a low expectation of
credit risk. The capacity for timely payment of financial commitments is
considered adequate, but adverse changes in circumstances and in economic
conditions are more likely to impair this capacity. This is the lowest
investment grade category.
"BB" - Securities considered to be speculative. These ratings indicate that
there is a possibility of credit risk developing, particularly as the result of
adverse economic change over time; however, business or financial alternatives
may be available to allow financial commitments to be met. Securities rated in
this category are not investment grade.
"B" - Securities are considered highly speculative. These ratings indicate
that significant credit risk is present, but a limited margin of safety remains.
Financial commitments are currently being met; however, capacity for continued
payment is contingent upon a sustained, favorable business and economic
environment.
"CCC", "CC" and "C" - Securities have high default risk. Default is a real
possibility, and capacity for meeting financial commitments is solely reliant
upon sustained, favorable business or economic developments. "CC" ratings
indicate that default of some kind appears probable, and "C" ratings signal
imminent default.
"DDD," "DD" and "D" - Securities are in default. The ratings of obligations
in this category are based on their prospects for achieving partial or full
recovery in a reorganization or liquidation of the obligor. While expected
recovery values are highly speculative and cannot be
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estimated with any precision, the following serve as general guidelines. "DDD"
obligations have the highest potential for recovery, around 90%-100% of
outstanding amounts and accrued interest. "DD" indicates potential recoveries in
the range of 50%-90%, and "D" the lowest recovery potential, i.e., below 50%.
Entities rated in this category have defaulted on some or all of their
obligations. Entities rated "DDD" have the highest prospect for resumption of
performance or continued operation with or without a formal reorganization
process. Entities rated "DD" and "D" are generally undergoing a formal
reorganization or liquidation process; those rated "DD" are likely to satisfy a
higher portion of their outstanding obligations, while entities rated "D" have a
poor prospect for repaying all obligations.
Notes to Fitch Long-Term and Short-Term Ratings:
------------------------------------------------
- To provide more detailed indications of credit quality, the Fitch ratings
from and including "AA" to "CCC" and "F1" may be modified by the addition of a
plus (+) or minus (-) sign to denote relative standing within these major rating
categories.
- `NR' indicates the Fitch does not rate the issuer or issue in question.
- `Withdrawn': A rating is withdrawn when Fitch deems the amount of
information available to be inadequate for rating purposes, or when an
obligation matures, is called, or refinanced.
- RatingWatch: Ratings are placed on RatingWatch to notify investors that
there is a reasonable probability of a rating change and the likely direction of
such change. These are designated as "Positive", indicating a potential upgrade,
"Negative", for a potential downgrade, or "Evolving", if ratings may be raised,
lowered or maintained. RatingWatch is typically resolved over a relatively short
period.
A Rating Outlook indicates the direction a rating is likely to move over a
one to two-year period. Outlooks may be positive, stable or negative. A positive
or negative Rating Outlook does not imply a rating change is inevitable.
Similarly, companies whose outlooks are "stable" could be upgraded or downgraded
before an outlook moves to positive or negative if circumstances warrant such an
action. Occasionally, Fitch may be unable to identify the fundamental trend. In
these cases, the Rating Outlook may be described as evolving.
Municipal Note Ratings
----------------------
A Standard and Poor's note rating reflects the liquidity factors and market
access risks unique to notes due in three years or less. The following
summarizes the ratings used by Standard & Poor's for municipal notes:
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"SP-1" - The issuers of these municipal notes exhibit a strong capacity to
pay principal and interest. Those issues determined to possess a very strong
capacity to pay debt service are given a plus (+) designation.
"SP-2" - The issuers of these municipal notes exhibit satisfactory capacity
to pay principal and interest, with some vulnerability to adverse financial and
economic changes over the term of the notes.
"SP-3" - The issuers of these municipal notes exhibit speculative capacity
to pay principal and interest.
Moody's ratings for state and municipal notes and other short-term loans
are designated Moody's Investment Grade ("MIG") and variable rate demand
obligations are designated Variable Moody's Investment Grade ("VMIG"). Such
ratings recognize the differences between short-term credit risk and long-term
risk. The following summarizes the ratings by Moody's Investors Service, Inc.
for short-term notes:
"MIG-1"/"VMIG-1" - This designation denotes superior credit quality.
Excellent protection afforded by established cash flows, highly reliable
liquidity support or demonstrated broad-based access to the market for
refinancing.
"MIG-2"/"VMIG-2" - This designation denotes strong credit quality. Margins
of protection are ample although not so large as in the preceding group.
"MIG-3"/"VMIG-3" - This designation denotes acceptable credit. Liquidity
and cash flow protection may be narrow and market access for refinancing is
likely to be less well established.
"SG" - This designation denotes speculative-grade credit quality. Debt
instruments in this category lack sufficient margins of protection.
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APPENDIX B
The Biotechnology Fund may enter into futures contracts and options. Such
transactions are described in this Appendix.
I. Interest Rate Futures Contracts.
--------------------------------
Use of Interest Rate Futures Contracts. Bond prices are established in both
--------------------------------------
the cash market and the futures market. In the cash market, bonds are purchased
and sold with payment for the full purchase price of the bond being made in
cash, generally within five business days after the trade. In the futures
market, only a contract is made to purchase or sell a bond in the future for a
set price on a certain date. Historically, the prices for bonds established in
the futures markets have tended to move generally in the aggregate in concert
with the cash market prices and have maintained fairly predictable
relationships. Accordingly, the Fund may use interest rate futures contracts as
a defense, or hedge, against anticipated interest rate changes and not for
speculation. As described below, this would include the use of futures contract
sales to protect against expected increases in interest rates and futures
contract purchases to offset the impact of interest rate declines.
The Fund presently could accomplish a similar result to that which it hopes
to achieve through the use of futures contracts by selling bonds with long
maturities and investing in bonds with short maturities when interest rates are
expected to increase, or conversely, selling short-term bonds and investing in
long-term bonds when interest rates are expected to decline. However, because of
the liquidity that is often available in the futures market the protection is
more likely to be achieved, perhaps at a lower cost and without changing the
rate of interest being earned by the Fund, by using futures contracts.
Description of Interest Rate Futures Contracts. An interest rate futures
----------------------------------------------
contract sale would create an obligation by the Fund, as seller, to deliver the
specific type of financial instrument called for in the contract at a specific
future time for a specified price. A futures contract purchase would create an
obligation by the Fund, as purchaser, to take delivery of the specific type of
financial instrument at a specific future time at a specific price. The specific
securities delivered or taken, respectively, at settlement date, would not be
determined until at or near that date. The determination would be in accordance
with the rules of the exchange on which the futures contract sale or purchase
was made.
Although interest rate futures contracts by their terms call for actual
delivery or acceptance of securities, in most cases the contracts are closed out
before the settlement date without the making or taking of delivery of
securities. Closing out a futures contract sale is effected by the Fund entering
into a futures contract purchase for the same aggregate amount of the specific
type of financial instrument and the same delivery date. If the price of the
sale exceeds the price of the offsetting purchase, the Fund is immediately paid
the difference and thus realizes a gain. If the offsetting purchase price
exceeds the sale price, the Fund pays the difference and realizes a loss.
Similarly, the closing out of a futures contract purchase is effected by the
Fund entering into a futures contract sale. If the offsetting sale price exceeds
the purchase
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price, the Fund realizes a gain, and if the purchase price exceeds the
offsetting sale price, the Fund realizes a loss.
Interest rate futures contracts are traded in an auction environment on the
floors of several exchanges -- principally, the Chicago Board of Trade and the
Chicago Mercantile Exchange and the New York Futures Exchange. The Fund would
deal only in standardized contracts on recognized exchanges. Each exchange
guarantees performance under contract provisions through a clearing corporation,
a nonprofit organization managed by the exchange membership.
A public market now exists in futures contracts covering various financial
instruments including long-term Treasury Bonds and Notes; Government National
Mortgage Association ("GNMA") modified pass-through mortgage-backed securities,
three-month Treasury Bills; and ninety-day commercial paper. The Fund may trade
in any futures contract for which there exists a public market, including,
without limitation, the foregoing instruments.
II. Stock Index Futures Contracts.
------------------------------
General. A stock index assigns relative values to the stocks included in
-------
the index and the index fluctuates with changes in the market values of the
stocks included. Some stock index futures contracts are based on broad market
indexes, such as the Standard & Poor's 500 or the New York Stock Exchange
Composite Index. In contrast, certain exchanges offer futures contracts on
narrower market indexes, such as the Standard & Poor's 100 or indexes based on
an industry or market segment, such as oil and gas stocks. Futures contracts are
traded on organized exchanges regulated by the Commodity Futures Trading
Commission. Transactions on such exchanges are cleared through a clearing
corporation, which guarantees the performance of the parties to each contract.
The Fund will sell index futures contracts in order to offset a decrease in
market value of its portfolio securities that might otherwise result from a
market decline. The Fund may do so either to hedge the value of its portfolio as
a whole, or to protect against declines, occurring prior to sales of securities,
in the value of the securities to be sold. Conversely, the Fund will purchase
index futures contracts in anticipation of purchases of securities. In a
substantial majority of these transactions, the Fund will purchase such
securities upon termination of the long futures position, but a long futures
position may be terminated without a corresponding purchase of securities.
In addition, the Fund may utilize stock index futures contracts in
anticipation of changes in the composition of its holdings. For example, in the
event that the Fund expects to narrow the range of industry groups represented
in its holdings it may, prior to making purchases of the actual securities,
establish a long futures position based on a more restricted index, such as an
index comprised of securities of a particular industry group. The Fund may also
sell futures contracts in connection with this strategy, in order to protect
against the possibility that the value of the securities to be sold as part of
the restructuring of its portfolio will decline prior to the time of sale.
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III. Futures Contracts on Foreign Currencies.
----------------------------------------
A futures contract on foreign currency creates a binding obligation on one
party to deliver, and a corresponding obligation on another party to accept
delivery of, a stated quantity of a foreign currency, for an amount fixed in
U.S. dollars. Foreign currency futures may be used by the Fund to hedge against
exposure to fluctuations in exchange rates between the U.S. dollar and other
currencies arising from multinational transactions.
IV. Margin Payments.
----------------
Unlike when the Fund purchases or sells a security, no price is paid or
received by the Fund upon the purchase or sale of a futures contract. Initially,
the Fund will be required to deposit with the broker or in a segregated account
with the Fund's custodian an amount of cash or cash equivalents, the value of
which may vary but is generally equal to 10% or less of the value of the
contract. This amount is known as initial margin. The nature of initial margin
in futures transactions is different from that of margin in security
transactions in that futures contract margin does not involve the borrowing of
funds by the customer to finance the transactions. Rather, the initial margin is
in the nature of a performance bond or good faith deposit on the contract which
is returned to the Fund upon termination of the futures contract assuming all
contractual obligations have been satisfied. Subsequent payments, called
variation margin, to and from the broker, will be made on a daily basis as the
price of the underlying instrument 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 Fund has purchased a futures contract
and the price of the contract has risen in response to a rise in the underlying
instruments, that position will have increased in value and the Fund will be
entitled to receive from the broker a variation margin payment equal to that
increase in value. Conversely, where the Fund has purchased a futures contract
and the price of the future contract has declined in response to a decrease in
the underlying instruments, the position would be less valuable and the Fund
would be required to make a variation margin payment to the broker. At any time
prior to expiration of the futures contract, the Fund may elect to close the
position by taking an opposite position, subject to the availability of a
secondary market, which will operate to terminate the Fund's position in the
futures contract. A final determination of variation margin is then made,
additional cash is required to be paid by or released to the Fund, and the Fund
realizes a loss or gain.
V. Risks of Transactions in Futures Contracts.
-------------------------------------------
There are several risks in connection with the use of futures by the Fund
as a hedging device. One risk arises because of the imperfect correlation
between movements in the price of the futures and movements in the price of the
securities which are the subject of the hedge. The price of the future may move
more than or less than the price of the securities being hedged. If the price of
the futures moves less than the price of the securities which are the subject of
the hedge, the hedge will not be fully effective but, if the price of the
securities being hedged has moved in an unfavorable direction, the Fund would be
in a better position than if it
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had not hedged at all. If the price of the securities being hedged has moved in
a favorable direction, this advantage will be partially offset by the loss on
the future. If the price of the future moves more than the price of the hedged
securities, the Fund involved will experience either a loss or gain on the
future which will not be completely offset by movements in the price of the
securities which are the subject of the hedge. To compensate for the imperfect
correlation of movements in the price of securities being hedged and movements
in the price of futures contracts, the Fund may buy or sell futures contracts in
a greater dollar amount than the dollar amount of securities being hedged if the
volatility over a particular time period of the prices of such securities has
been greater than the volatility over such time period of the future, or if
otherwise deemed to be appropriate by the Fund. Conversely, the Fund may buy or
sell fewer futures contracts if the volatility over a particular time period of
the prices of the securities being hedged is less than the volatility over such
time period of the future contract being used, or if otherwise deemed to be
appropriate by the Fund. It is also possible that, where the Fund has sold
futures to hedge its portfolio against a decline in the market, the market may
advance and the value of securities held in the Fund may decline. If this
occurred, the Fund would lose money on the future and also experience a decline
in value in its portfolio securities.
Where futures are purchased to hedge against a possible increase in the
price of securities or a currency before the Fund is able to invest its cash (or
cash equivalents) in securities (or options) in an orderly fashion, it is
possible that the market may decline instead; if the Fund then concludes not to
invest in securities or options at that time because of concern as to possible
further market decline or for other reasons, the Fund will realize a loss on the
futures contract that is not offset by a reduction in the price of securities to
be purchased.
In addition to the possibility that there may be an imperfect correlation,
or no correlation at all, between movements in the futures and the securities
being hedged, the price of futures may not correlate perfectly with movement in
the cash market due to certain market distortions. Rather than meeting
additional margin deposit requirements, investors may close futures contracts
through off-setting transactions which could distort the normal relationship
between the cash and futures markets. Second, with respect to financial futures
contracts, the liquidity of the futures market depends on participants entering
into off-setting transactions rather than making or taking delivery. To the
extent participants decide to make or take delivery, liquidity in the futures
market could be reduced thus producing distortions. Third, from the point of
view of speculators, the deposit requirements in the futures market are less
onerous than margin requirements in the securities market. Therefore, increased
participation by speculators in the futures market may also cause temporary
price distortions. Due to the possibility of price distortion in the futures
market, and because of the imperfect correlation between the movements in the
cash market and movements in the price of futures, a correct forecast of general
market trends or interest rate movements by the Fund may still not result in a
successful hedging transaction over a short time frame.
Positions in futures may be closed out only on an exchange or board of
trade which provides a secondary market for such futures. Although the Fund
intends to purchase or sell futures only on exchanges or boards of trade where
there appear to be active secondary markets, there is no assurance that a liquid
secondary market on any exchange or board of trade
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will exist for any particular contract or at any particular time. In such event,
it may not be possible to close a futures investment position, and in the event
of adverse price movements, the Funds would continue to be required to make
daily cash payments of variation margin. However, in the event futures contracts
have been used to hedge portfolio securities, such securities will not be sold
until the futures contract can be terminated. In such circumstances, an increase
in the price of the securities, if any, may partially or completely offset
losses on the futures contract. However, as described above, there is no
guarantee that the price of the securities will in fact correlate with the price
movements in the futures contract and thus provide an offset on a futures
contract.
Further, it should be noted that the liquidity of a secondary market in a
futures contract may be adversely affected by "daily price fluctuation limits"
established by commodity exchanges which limit the amount of fluctuation in a
futures contract price during a single trading day. Once the daily limit has
been reached in the contract, no trades may be entered into at a price beyond
the limit, thus preventing the liquidation of open futures positions. The
trading of futures contracts is also subject to the risk of trading halts,
suspensions, exchange or clearing house equipment failures, government
intervention, insolvency of a brokerage firm or clearing house or other
disruptions of normal trading activity, which could at times make it difficult
or impossible to liquidate existing positions or to recover excess variation
margin payments.
Successful use of futures by the Fund is also subject to the Fund's ability
to predict correctly movements in the direction of the market. For example, if
the Fund has hedged against the possibility of a decline in the market adversely
affecting securities held in its Portfolio and securities prices increase
instead, the Fund will lose part or all of the benefit to the increased value of
its securities which it has hedged because it will have offsetting losses in its
futures positions. In addition, in such situations, if the Fund has insufficient
cash, it may have to sell securities to meet daily variation margin
requirements. Such sales of securities may be, but will not necessarily be, at
increased prices which reflect the rising market. The Fund may have to sell
securities at a time when it may be disadvantageous to do so.
VI. Options on Futures Contracts
----------------------------
The Fund may purchase options on the futures contracts described above. A
futures option gives the holder, in return for the premium paid, the right to
buy (call) from or sell (put) to the writer of the option a futures contract at
a specified price at any time during the period of the option. Upon exercise,
the writer of the option is obligated to pay the difference between the cash
value of the futures contract and the exercise price. Like the buyer or seller
of a futures contract, the holder, or writer, of an option has the right to
terminate its position prior to the scheduled expiration of the option by
selling, or purchasing, an option of the same series, at which time the person
entering into the closing transaction will realize a gain or loss.
Investments in futures options involve some of the same considerations that
are involved in connection with investments in futures contracts (for example,
the existence of a liquid secondary market). In addition, the purchase or sale
of an option also entails the risk that
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changes in the value of the underlying futures contract will not be fully
reflected in the value of the option purchased. Depending on the pricing of the
option compared to either the futures contract upon which it is based, or upon
the price of the securities being hedged, an option may or may not be less risky
than ownership of the futures contract or such securities. In general, the
market prices of options can be expected to be more volatile than the market
prices on the underlying futures contract. Compared to the purchase or sale of
futures contracts, however, the purchase of call or put options on futures
contracts may frequently involve less potential risk to the Fund because the
maximum amount at risk is the premium paid for the options (plus transaction
costs). The writing of an option on a futures contract involves risks similar to
those risks relating to the sale of futures contracts. Although permitted by
their fundamental investment policies, the Fund does not currently intend to
write futures options during the current fiscal year, and will not do so in the
future absent any necessary regulatory approvals.
VII. Accounting and Tax Treatment.
-----------------------------
Accounting for futures contracts and options will be in accordance with
generally accepted accounting principles.
Generally, futures contracts held by the Fund at the close of the Fund's
taxable year will be treated for federal income tax purposes as sold for their
fair market value on the last business day of such year, a process known as
"mark-to-market." Forty percent of any gain or loss resulting from such
constructive sale will be treated as short-term capital gain or loss and sixty
percent of such gain or loss will be treated as long-term capital gain or loss
without regard to the length of time the Fund holds the futures contract ("the
40-60 rule"). The amount of any capital gain or loss actually realized by the
Fund in a subsequent sale or other disposition of those futures contracts will
be adjusted to reflect any capital gain or loss taken into account by the Fund
in a prior year as a result of the constructive sale of the contracts. With
respect to futures contracts to sell, which will be regarded as parts of a
"mixed straddle" because their values fluctuate inversely to the values of
specific securities held by the Fund, losses as to such contracts to sell will
be subject to certain loss deferral rules which limit the amount of loss
currently deductible on either part of the straddle to the amount thereof which
exceeds the unrecognized gain (if any) with respect to the other part of the
straddle, and to certain wash sales regulations. Under short sales rules, which
will also be applicable, the holding period of the securities forming part of
the straddle will (if they have not been held for the long-term holding period)
be deemed not to begin prior to termination of the straddle. With respect to
certain futures contracts, deductions for interest and carrying charges will not
be allowed. Notwithstanding the rules described above, with respect to futures
contracts to sell which are properly identified as such, the Fund may make an
election which will exempt (in whole or in part) those identified futures
contracts from being treated for federal income tax purposes as sold on the last
business day of the Fund's taxable year, but gains and losses will be subject to
such short sales, wash sales, loss deferral rules and the requirement to
capitalize interest and carrying charges. Under temporary regulations, the Fund
would be allowed (in lieu of the foregoing) to elect either (1) to offset gains
or losses from portions which are part of a mixed straddle by separately
identifying each mixed straddle to which such treatment applies, or (2) to
establish a mixed straddle account for which gains and losses would be
recognized and offset on a periodic
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basis during the taxable year. Under either election, the 40-60 rule will apply
to the net gain or loss attributable to the futures contracts, but in the case
of a mixed straddle account election, no more than 50% of any net gain may be
treated as long-term and no more than 40% of any net loss may be treated as
short-term. Options on futures contracts generally receive federal tax treatment
similar to that described above.
Certain foreign currency contracts entered into by the Fund may be subject
to the "mark-to-market" process. If the Fund makes a Capital Asset Election with
respect to such contracts, the contracts will be subject to the 40-60 rule,
described above. Otherwise, such gain or loss will be treated as 100% ordinary
gain or loss. To receive such federal income tax treatment, a foreign currency
contract must meet the following conditions: (1) the contract must require
delivery of a foreign currency of a type in which regulated futures contracts
are traded or upon which the settlement value of the contract depends; (2) the
contract must be entered into at arm's length at a price determined by reference
to the price in the interbank market; and (3) the contract must be traded in the
interbank market. The Treasury Department has broad authority to issue
regulations under the provisions respecting foreign currency contracts. As of
the date of this Statement of Additional Information, the Treasury has not
issued any such regulations. Foreign currency contracts entered into by the Fund
may result in the creation of one or more straddles for federal income tax
purposes, in which case certain loss deferral, short sales, and wash sales rules
and the requirement to capitalize interest and carrying charges may apply.
Some investments may be subject to special rules which govern the federal
income tax treatment of certain transactions denominated in terms of a currency
other than the U.S. dollar or determined by reference to the value of one or
more currencies other than the U.S. dollar. The types of transactions covered by
the special rules include the following: (i) the acquisition of, or becoming the
obligor under, a bond or other debt instrument (including, to the extent
provided in Treasury regulations, preferred stock); (ii) the accruing of certain
trade receivables and payables; and (iii) the entering into or acquisition of
any forward contract, futures contract, option and similar financial instrument.
However, regulated futures contracts and non-equity options are generally not
subject to the special currency rules if they are or would be treated as sold
for their fair market value at year-end under the "mark-to-market" rules, unless
an election is made to have such currency rules apply. The disposition of a
currency other than the U.S. dollar by a U.S. taxpayer is also treated as a
transaction subject to the special currency rules. With respect to transactions
covered by the special rules, foreign currency gain or loss is calculated
separately from any gain or loss on the underlying transaction and is normally
taxable as ordinary gain or loss. A taxpayer may elect to treat as capital gain
or loss foreign currency gain or loss arising from certain identified forward
contracts, futures contracts and options that are capital assets in the hands of
the taxpayer and which are not part of a straddle. In accordance with Treasury
regulations, certain transactions subject to the special currency rules that are
part of a "section 988 hedging transaction" (as defined in the Code and the
Treasury regulations) will be integrated and treated as a single transaction or
otherwise treated consistently for purposes of the Code. "Section 988 hedging
transactions" are not subject to the mark-to-market or loss deferral rules under
the Code. It is anticipated that some of the non-U.S. dollar denominated
investments and foreign currency contracts that the Fund may make or may enter
into will be subject to the special currency rules described above. Gain or loss
attributable to the foreign
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currency component of transactions engaged in by the Fund which are not subject
to special currency rules (such as foreign equity investments other than certain
preferred stocks) will be treated as capital gain or loss and will not be
segregated from the gain or loss on the underlying transaction.
Under the federal income tax provisions applicable to regulated investment
companies, less than 30% of a company's gross income must be derived from gains
realized on the sale or other disposition of securities held for less than three
months. With respect to futures contracts and other financial instruments
subject to the "mark-to-market" rules, the Internal Revenue Service has ruled in
private letter rulings that a gain realized from such a futures contract or
financial instrument will be treated as being derived from a security held for
three months or more (regardless of the actual period for which the contract or
instrument is held) if the gain arises as a result of a constructive sale under
the "mark-to-market" rules, and will be treated as being derived from a security
held for less than three months only if the contract or instrument is terminated
(or transferred) during the taxable year (other than by reason of the
mark-to-market rules) and less than three months have elapsed between the date
the contract or instrument is acquired and the termination date. In determining
whether the 30% test is met for a taxable year, increases and decreases in the
value of the Fund's futures contracts and other investments that qualify as part
of a "designated hedge," as defined in the Code, may be netted.
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